2019 is a big year for tax professionals. After a long period of legislative near-stasis, the changes wrought by the Tax Cuts and Jobs Act of 2017 have prompted a level of client interest and engagement not seen for quite some time. This year it seems that everyone, quite naturally, has questions about how the new laws will affect their income tax bill and among the most common questions we’ve seen here at Brighton Jones is this:
What’s going on with the mortgage interest deduction and can I still deduct interest on a second mortgage?
Because the tax code is largely written by people with law degrees, the answer is a resounding “it depends.”
There are three main questions that will determine whether the interest paid on additional mortgages (whether home equity second mortgages or mortgages on a second home) is deductible, and we’ll walk through these below.
1. What is the money from the loan used for?
Starting in tax year 2018 (returns due April 15, 2019), only interest paid on “acquisition indebtedness” may be deducted. This means that interest is only deductible if the loan was used either to acquire, build, or “substantially improve” a main or second home. For example, interest on a home equity loan used to update your kitchen with the latest industrial countertops and internet-enabled appliances will still be deductible. Interest on a home equity loan used to realize your dream of owning a classic air-cooled Porsche 911, however, will no longer be deductible.
This restriction applies regardless of when the loan originated—nothing is grandfathered. Therefore, interest you were able to deduct on your 2017 return may suddenly be non-deductible on your 2018 return. If you have a home equity mortgage, you should discuss this issue with your tax preparer to ensure that they are aware of how you have used the funds from your home equity mortgage.
Note that the acquisition indebtedness must apply to the home that is used to secure the mortgage. For example, interest on a mortgage used to purchase a second home that is secured by the second home is deductible but interest on a home equity loan used to purchase a second home that is secured by the taxpayer’s main home is not deductible. This is a relatively rare scenario, but if it applies to you, you should discuss it in more depth with your tax planning professional.
2. How much total mortgage debt is outstanding?
Prior to the 2018 tax year, individuals could deduct the interest on up to $1,000,000 ($500,000 if married filing separately) of qualifying debt, but the Tax Cuts and Jobs Act reduced the maximum loan amount to $750,000 ($375,000 if married filing separately). If your total principal amount outstanding is $750,000 ($375,000 if married filing separately) or less, you can deduct the full amount of interest paid on all mortgages for a main or second home so long as the mortgages were used for acquisition indebtedness as described above in question one. If your total principal amount outstanding is over $750,000 ($375,000 if married filing separately), then you may only be able to deduct a pro-rata amount of interest depending on the answer to the next question.
3. When did the mortgage originate?
If your mortgage originated on or before December 15, 2017, congratulations, you are grandfathered into the prior tax treatment and may deduct interest on up to $1,000,000 ($500,000 if married filing separately) of mortgage principal provided that the loan was used to buy, build, or substantially improve a main or second home. For loans originating after December 15, 2017, you may only deduct interest on a mortgage principal of up to $750,000 ($375,000 if married filing separately).
Note, however, that having one grandfathered loan does not pull new loans into the same status. For example, if you have $800,000 of outstanding mortgage principal on a loan that originated on or before December 15, 2017, you cannot then take out a new mortgage for $200,000 today and deduct interest on the full $1,000,000 of principal debt—you would be limited to deducting only the interest on the $800,000 of grandfathered mortgage debt.
The good news is that interest on mortgages for a second home and home equity loans is generally still deductible. Although exactly how much of that interest is deductible will depend on what the loans were used for, how much principal remains outstanding, and when the loans originated, as long as you provide that information to your tax professional, they will be able to ensure that you receive the maximum mortgage interest deduction possible.
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