By Ryan C. Raffensperger, CPA | Martin & Finkenbiner LLC
The Tax Cuts and Jobs Act of 2017 has brought sweeping changes to the Tax Code. But along with these changes comes a rush of questions from taxpayers about how new tax rules will affect them. Television media reports have a 60- to 90-second window for explanation, and news writing attempts to tell the story as briefly as possible. Both sadly reduce the details within their content.
Therefore, there is quite a bit of misunderstanding about the changes that have been made and their impact. One area of confusion involves changes made to the mortgage interest deduction. Several changes have been made to the itemized deductions portion of the code that affect the mortgage interest deduction, so some of the confusion is understandable.
Deductible mortgage interest is classified as qualified acquisition indebtedness (QAI), and the interest paid against the QAI of a home is 100 percent deductible to the extent the purchase price does not exceed $750,000. Previous purchases were allowed an interest deduction on purchase prices up to $1 million. Purchases made before Dec. 14, 2017, can continue to claim interest on home mortgages on prices up to $1 million.
Interest on refinanced mortgages are deductible to the extent that they pay for costs of the original purchase in the original mortgage. For example, say a $300,000 mortgage on the original purchase of a $400,000 home has been paid down to $200,000. If the owners decide to refinance, the interest on what remains of the original mortgage, $200,000, is fully deductible. However, if a refinanced loan is for $250,000 to pay off the previous mortgage and provide $50,000 for the purchase of a vehicle, only the interest on the $200,000 is deductible. IRS Publication 936 provides calculators for mixed-use mortgages to determine deductibility under the previous rules. To date, those worksheets have yet to be updated to reflect changes from the Tax Cuts and Jobs Act.
Note, home equity interest is no longer deductible. There are no exceptions to the rule. Unlike the cap on the mortgage interest deduction, a grandfathering period does not exist. Home equity interest from a loan that was deductible in 2017 is not deductible in 2018.
Several other changes will affect the mortgage interest deduction.
The increased standard deduction will mean it is less likely that the mortgage interest will be included in the calculation. Many taxpayers who previously itemized their deductions will receive an increased deduction via the standard deduction.
Lower tax rates mean that the tax savings from mortgage interest paid will be less of a benefit. In the past, a 25 percent tax bracket taxpayer paying on ordinary income, who paid $1,000 in mortgage interest and itemized their deductions, saw their tax liability decreased by $250. That same taxpayer’s tax liability would likely result in only a $220 reduction because of the interest paid. Still, it is likely that the taxpayer’s total liability decreased even with the above as the 3 percent reduction on taxable income would most likely exceed the $30 variance.
The Pease limitation on itemized deductions was suspended beginning with the 2018 tax year. Therefore, all taxpayers will receive a full deduction on allowable deductions instead of having those deductions reduced because of income thresholds in the past.
The mortgage interest deduction is important to many, and hopefully this summary of the changes to that deduction included in the Tax Cuts and Jobs Act offers some helpful guidance.
Ryan Raffensperger CPA, is a partner with Raffensperger, Martin & Finkenbiner LLC in Gettysburg, Pa.