Tax Law Impacts For Homeowners
Rumor has it...
If you watch the news or speak to other people, you’ve probably heard something about the new tax law. Whether you were surprised when filing your 2017 taxes that there were few, if any, changes to your bottom line compared to last year, or you knew that most of the changes are slated to take effect for returns filed in calendar year 2019, you probably had some questions about the impact to your individual situation.
One particular group of taxpayers suffering from fear and confusion are current and future homeowners.
What is Unchanged by the NEw Law?
Deduction for Points
Under the current law, borrowers can often deduct points (prepaid interest). The rules currently allow an upfront deduction for the year of acquisition on debt that is used to buy, build or improve a principal residence, and a deduction over time for points paid to refinance a principal residence or buy, build, improve or refinance a second home. The new law does not change this provision.
Exclusion of Gain on Principal Residence
When selling a home that was a principal residence for at least two of the last five years, the current law allows an exclusion on gain of $250,000 for individuals and $500,000 for married couples filing jointly. The exclusion will remain in place under the new law.
Mortgage Insurance Premiums
The mortgage insurance deduction for Conventional loans, FHA loans and their equivalents (funding fee for VA loans and guarantee fee for USDA loans) was allowed to expire at the end of 2017, but was retroactively renewed by Congress in February 2018, allowing the deduction on 2017 federal tax returns. The current provision is set to expire at the end of 2018 unless Congress extends it again for 2018 tax returns (filed in calendar year 2019).
What is changed by the new law?
Let’s play a game called two truths and a lie. Two of the following statements are true, the third is false. Can you guess which is which?
Statement 1: Interest on up to $1M of mortgage debt can be deducted if the loan was originated before December 15th, 2017.
Statement 2: Interest on home equity lines is no longer deductible in any circumstance.
Statement 3: The deduction for state and local taxes (including property tax) is limited to $10,000.
Keep reading for the answer.
Property Tax Deduction
The new law limits the deduction for state and local taxes (commonly referred to as SALT) to $10,000. This includes income taxes paid during the calendar year for state and local income tax, sales tax and personal and real property taxes. For homeowners in high-property tax locations, the new law will severely reduce their deductions. If you guessed Statement 3 was true, you were correct.
In order to understand what’s actually changing, it’s important to first define a few key terms:
- Acquisition Debt: The IRS defines acquisition debt as the cost to buy or build a primary residence or second home, plus the cost of improvements that increase the value of the home (not repairs) up to a limit of $1M under the current law.
- Equity Debt: Any debt that does not meet the above definition up to an additional $100,000.
Under the current law, interest paid on acquisition debt and equity debt (as defined above) is fully deductible. Per the new law, the limit for acquisition debt is decreasing to $750,000 and the deduction will now be limited to interest incurred on a principal residence, not a second home.
However, for acquisition debt in place before December 15th, 2017, the limit will remain $1M. If you guessed Statement 1 was true, you were correct.
That leaves Statement 2. The simplest way to understand what can be deducted as mortgage interest is to focus on what the funds are used for, rather than the type of loan.
After much confusion, the IRS issued a statement to clarify that the interest on any equity loan or line used to buy, build or improve a qualified residence (i.e. acquisition debt) would still be deductible, as long as the total debt was within the $750,000 (or $1M) limit.
The good news is that, as under the current law, even if the interest is not deductible as mortgage or home equity interest, it may still be deductible under another guideline. For example, the interest on equity line proceeds used in place of a student loan can be deducted as student loan interest.