Maximizing Mortgage Interest Deductions Under the New Tax Law

QTA Consultants, Ltd./Renata Bliumaite

Maximizing Mortgage Interest Deductions Under the New Tax Law

The new tax law—the Tax Cuts and Jobs Act (TCJA) of 2017—has introduced stricter rules for mortgage interest deductions on home equity loans. However, there is a strategy you can employ to turn these new regulations to your advantage.

Strategy: Use Home Equity Loans for Home Improvements

To maximize your tax benefits under the TCJA, use the proceeds of a home equity loan for home improvements. According to the new law, this can help you avoid the restrictions on mortgage interest deductions that take effect in 2024. The key lies in the distinction between loans classified as “acquisition debt” and those labeled as “home equity debt.”

Understanding the Tax Distinctions

Acquisition Debt: This is debt incurred to buy, build, or substantially improve a qualified home. Before the TCJA, mortgage interest on up to $1 million of acquisition debt was fully deductible if you itemized your deductions.

Home Equity Debt: This includes any other qualified debt, such as a home equity loan or line of credit. Previously, interest on up to $100,000 of home equity debt was deductible, regardless of how the funds were used. However, the TCJA has changed this.

New Limits Under the TCJA

For acquisition debt, the TCJA lowers the deductible limit from $1 million to $750,000 for 2018 through 2025. This new limit generally applies to mortgage loans taken out after December 15, 2017. Existing acquisition debt up to $1 million is grandfathered in, even if it is refinanced, as long as the amount of debt does not increase.

However, the deduction for interest on home equity debt is eliminated for 2018–2025.

Tax Loophole: Treat Home Equity Loans as Acquisition Debt

If you take out a new home equity loan or line of credit and use the proceeds for home improvements—such as finishing a basement or building a new deck—the debt is treated as acquisition debt rather than home equity debt. Since it is a debt incurred to “substantially improve” a qualified residence, the interest can be deducted, provided the total acquisition debt remains below the $750,000 threshold.

Practical Application

A small change in how you use your funds can help you retain your deductions. For instance, instead of using your savings for home improvements and a home equity loan for your child's college expenses, you could do the opposite. This approach converts a nondeductible interest expense into a deductible one.

IRS Approval

The IRS has approved this interpretation of the rules (IRS Information Release IR-2018-32, dated 2/21/18).

By employing this strategy, you can optimize your mortgage interest deductions under the new tax law, ensuring that you benefit from the available tax advantages. For expert guidance on this and other tax strategies, contact QTA Tax, Ltd., your trusted accountant in Oak Brook.