Use Your HELOC Wisely in 2020!

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Once upon a time, a homeowner had a nice tax deduction for interest paid on a home equity line of credit, also known as a HELOC. But then, something called tax reform happened, and homeowners went into a tailspin of worry. This new law was called the Tax Cuts and Jobs Act of 2017, in case you’ve forgotten.

Under the old law, if a homeowner itemized deductions, they could deduct qualifying mortgage interest for home purchases up to $1 million, plus an additional $100,000 for equity line debt. Homeowners didn’t have to worry what they did with the HELOC proceeds. Now, if a taxpayer uses their home equity loan for personal expenses, such as taking a trip around the world or funding their child’s college education, then the interest is no longer deductible.

Since the new law looked like it was going to eliminate any and all interest deduction, the Internal Revenue Service tried to calm homeowners’ nerves by clarifying the new rules. According to the IRS, “despite newly enacted restrictions on home mortgages, homeowners can often continue to deduct interest on a home equity loan, home equity line of credit or second mortgage, regardless of how the loan is labeled.”

Of note, the new law does eliminate the deduction for interest paid on HELOCs through the year 2026 unless they are used to buy, build or substantially improve the home that secures the loan.
So, what does this gobbledygook mean?

Simply put, homeowners can still deduct interest on debt secured by their home, as long as the total amount owed does not exceed the total dollar threshold of $750,000, and once again, is incurred in acquiring, constructing or substantially improving a qualified residence of the taxpayer. Beginning in 2018, the IRS set this cap of $750,000 on the total amount of qualified loans eligible for deductions. Taxpayers could deduct interest on only $750,000 of new qualified residence loans for those who choose married, filing jointly, which includes mortgages and HELOCs.
Due to the uproar and volume of calls and complaints from taxpayers, the IRS decided to explain the law by offering a few examples.

A home costs $500,000 and the homeowner takes out a $300,000 mortgage to purchase it. Then, the homeowner decides to take out a $75,000 HELOC to build a new swimming pool. In this case, both loans are secured by the home and together, they amount to $375,000 in total loan debt. But because both loans don’t exceed the cost of the fair value of the home and the total amount of both loans doesn’t exceed $750,000, all of the interest paid on both loans is tax deductible.

A home costs $500,000 and the homeowner has a mortgage secured by the house. Then the homeowner decides to buy a mountain vacation home and takes out a $200,000 loan to purchase it. That new loan is secured by the mountain home. The total amount of both of these loans doesn’t exceed the $750,000 threshold and all of the interest paid on both of these loans is deductible. But here is the kicker in this example: if the homeowner took out a $200,000 home equity loan on her main home to buy the mountain home, then the interest on the home equity loan would not be deductible.

Keep in mind that the dollar threshold for loans is $750,000 for married couples. That means that homeowners can deduct interest on loans that add up to $750,000. For single filers, it is only $375,000. However, if two unmarried people pool their limits, they could potentially deduct $1.5 million in mortgage debt if they buy a home together, according to a ruling by the Ninth Circuit Court of Appeals, Voss vs IRS, August 2015. The limit is per residence rather than per person

Taxpayers are lucky that earlier versions of the Tax Cuts and Jobs Act didn’t get passed that would have completely eliminated loan interest deduction. And remember that this will only last through 2026.

Home equity lines of credit are still a good bargain, even if homeowners don’t get the tax deduction they enjoyed prior to 2018. Rates are generally lower for these types of loans since they are tied to a home’s value and banks love solid collateral. So, it may still make sense to pay down a high-interest credit card with a home equity line since the interest rate would be lower. And homeowners can still go on a wild shopping spree or fly around the world; it just won’t be tax deductible like it was before TCJA.

As always, be prepared for tax season by checking in with a professional before making any important tax decisions. ■

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