As we enter the middle of Tax Season 2021, I’m hearing a lot of people asking the following questions about their mortgage interest, “Can I still deduct my home equity line of credit? Should I refinance to make it tax-deductible again? How do I know if I can deduct the home equity line of credit (HELOC) interest?” Below, we will answer your questions and more.
Home Equity Lines of Credit (HELOC) Basics
This mortgage tax break continues to confuse many homeowners when filing taxes. Adding to the confusion are the mortgage tax deduction changes in the Tax Cuts and Jobs Act (TCJA) of 2017. I have been vocal over the years about how bad these changes are for most of my home-owning clients.
For many homeowners, there are quite a few cases where the interest on a HELOC can be deductible, but there are also many times HELOC interest will not be tax-deductible. For those with valuable real estate holdings, just a portion of your mortgage and home equity loan are tax-deductible. It all depends on your specific situation and is mostly based on your mortgage balance and what the mortgage debt was used for.
As a Los Angeles financial advisor, many of my clients live in locales with high property values. The Tax Cuts and Jobs Act of 2017 screws many people who have grown accustomed to receiving a tax break for the interest they pay on home equity loans and lines of credit. Some will see their tax breaks scaled back, others may see their entire tax deduction eliminated.
To help reduce the confusion, the Internal Revenue Service (IRS) issued an advisory which you can read here. From the advisory, we get some of the details of what will be deductible and what will not. For the tax years 2018 through 2025, you will not be able to deduct HELOCs. There are, however, a few exceptions. If you plan on taking this deduction, your loan must be used to “buy, build or substantially improve” the residence that secures the underlying loan.
What Debt Does or Does Not Qualify For the Mortgage Deduction?
If you are using the home equity loan for home improvements, you can still deduct the interest. This would apply to things like replacing the roof, adding solar panels, or remodeling a kitchen or bathroom. I am sorry to let you know that furniture and home décor are not eligible expenses.
On the other hand, if you are just raiding your home equity to fund a lifestyle your income won’t support, you will not be able to deduct the home equity interest. Your plan to pay for your kid’s college with home equity might also be out the window. Likewise, you can no longer use the money to pay off credit card debt, student loans or use it to buy that new electric car you’ve been eyeing. In the end, what you use the money for is up to you. Whether or not that use is deductible is up to the IRS.
Limits to Home Equity Loan Tax Deductions Amounts
Generally, homeowners may deduct interest paid on HELOC debt up to a max of $100,000. The new regulations contain some fine print you probably weren’t aware of. The HELOC deduction is limited to the purchase price of the home. This may trip up some of you who have owned your home for decades or perhaps bought a real fixer-upper. For example, let’s say you purchased a home for $70,000 and plan to put a ton of work into it. In this case, you would only be able to deduct interest paid up to $70,000, if using a HELOC. That’s not a huge issue in Los Angeles, where $70,000 doesn’t buy you a studio condo (probably barely buys an outhouse….), but it can be a bigger issue in many other parts of the country.
Also worth noting is the new tax plan lowers the dollar limits on traditional mortgages. This change took effect in 2018; taxpayers can only deduct interest on $750,000 in home loans. This only applies to homes purchased after December 16th, 2017. Homeowners who purchased their homes before that date can still deduct up to $1 million in principal mortgage debt.
Another thing to be aware of is the fact that the $750,000 limit applies to the combined total of all debt on all properties owned. For example, if you have a $400,000 mortgage on your primary residence and owe $350,000 on a home in Palm Springs, the entire amount gets a tax break. But if your primary residence is $750,000 and your secondary home is $250,000, you would only get a tax break on $750,000, and none of your paid interest on the second home would be deductible.
For my single readers, there is a bit of good news here. Two singles could potentially deduct a combined $1.5 million in mortgage debt ($750,000 each) if they went in together on the purchase of a home. A married couple, however, would be limited to $750,000.
If you find that your head is spinning after reading about these tax laws, you are not alone. Mortgage deduction and other tax breaks for real estate can be confusing. The main takeaway is to be proactive, so you don’t get whacked with a sky-high tax bill when filing in 2021. The more you make, the more valuable tax breaks can be.