By Heather M. Demshock, CPA
As tax season heats up, those thinking ahead may be wondering how the Tax Cuts and Jobs Act of 2017 will alter their tax situation in the future. There are important changes for individuals in the bill, not the least of which is the elimination of the home equity interest deduction.
Prior to the new tax bill, taxpayers had been permitted to take a tax deduction for home equity interest on loans or line-of-credit balances up to $100,000. Under previous guidance, the taxpayer had no restrictions on how the loan proceeds were used. Regardless of whether they spent it on improvements to their homes, a new car, education, or even a grand tour of Europe, the interest on the home equity loan was deductible for tax purposes and included among the itemized deductions.
When President Donald Trump signed the new tax bill into law, the home equity interest deduction for new and old home equity loans was terminated. In other words, taxpayers with current home equity loans will not be grandfathered under the old rules. For the next tax filing season, the deduction is gone.
Or is it?
There are two schools of thought as to how the tax act will affect the home equity loan interest deduction. Some professionals believe it has been permanently eliminated, with no regard for how the proceeds were used. But a careful reading of the tax bill shows that Congress eliminated the ability to deduct interest on debt that is considered home equity indebtedness. Tax law splits qualified residence interest into two categories: acquisition indebtedness and home equity indebtedness. According to the Internal Revenue Code, acquisition indebtedness is the outstanding amount of debt incurred in acquiring, constructing, or improving property. Under this definition, any improvements made to a property would qualify as acquisition indebtedness; thus the interest would be deductible, regardless of whether those improvements were financed with a mortgage or home equity loans or lines of credit.
Keep in mind that the tax act also lowered the interest deduction on acquisition indebtedness of $1 million to $750,000. This $750,000 cap could include acquisition indebtedness resulting from a mortgage or home equity loan used for home acquisitions or improvements. The IRS has not issued guidance on its position as to whether or not home equity loans used for improvements could count as acquisition indebtedness. Accordingly, it is too soon to tell how the law will be applied.
Regardless of which side of the debate one falls on, home equity loans and lines of credit remain among the cheapest methods to borrow money. The interest rates for most taxpayers on home equity loans are much lower than personal bank loans. Therefore, even without the ability to generate a tax deduction, home equity loans still provide a way for taxpayers to reasonably finance home improvements or other life events.
Heather M. Demshock, CPA, is an assistant professor of accounting at Lycoming College in Williamsport, Pa. She can be reached at firstname.lastname@example.org.