Interest Paid

The definition of qualified interest expenses in this section of Itemized deductions seems to change year to year. I can remember when including interest on credit cards, auto loans and mortgages, all qualified. For 2018 tax purposes only acquisition indebtedness qualifies as deductible home mortgage interest. According to the new rules acquisition indebtedness is incurred in acquiring, constructing, or substantially improving a qualified residence of the taxpayer and which secures the residence. For home owners, this has been a major contributor to reducing taxes by causing some filers itemized deductions to exceed the standard deduction ceiling.

There is an exception. Previously included as mortgage interest was interest paid on home equity loan or line of credit. Even though these loans are secured by the residence they are no longer eligible as deductible mortgage interest under the new laws. The interest is not deductible unless, the home equity loan or line of credit is used to buy, build, or substantially improve the taxpayers home that it secures.

As of December 15, 2017, the limit on acquisition indebtedness is $750,000 ($375,000 for married taxpayers filing separately). This limit applies to the combined amount of loans use to buy, build, or substantially improve a taxpayer’s main home and second home. The old ceiling was $1,000,000 ($500,000 for married taxpayers filing separately). Also excluded from the new lower ceiling are purchases under a binding contract in effect before 12/16/17, where the home purchased closed before 04/01/18.

Example 1: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000. In February 2018, the taxpayer takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total does not exceed the cost of the home. Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible. However, if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan would not be deductible.

Example 2: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $250,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages does not exceed $750,000, all of the interest paid on both mortgages is deductible. However, if the taxpayer took out a $250,000 home equity loan on the main home to purchase the vacation home, then the interest on the home equity loan would not be deductible.

Example 3: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $500,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. A percentage of the total interest paid is deductible (see Publication 936).