The New Tax Act's Effect on Homeowners

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Traditionally, tax law provides numerous incentives for home ownership by allowing the deduction for mortgage interest and real estate tax. The Tax Cuts and Jobs Act modifies these popular tax benefits.


Mortgage Interest

Prior to 2018, home mortgage interest was deductible if paid or accrued on acquisition indebtedness or home equity indebtedness secured by a taxpayer's principal or second residence. The deduction for acquisition indebtedness was limited to interest paid on the first $1 million of debt ($500,000 for a married taxpayer filing a separate return (MFS)). Home equity loans were allowed an additional $100,000 ($50,000 for MFS).


Under the Tax Cuts and Jobs Act, a taxpayer may treat no more than $750,000 as acquisition indebtedness ($375,000 for MFS) in tax years starting after December 31, 2017. While this limit may be split among principal and second residences, interest on home equity loans has been completely disallowed. Existing mortgages - those incurred on homes purchased before December 15, 2017 - will continue to allow interest to be deducted up to the old ($1 million) debt limit. A transitional rule grants relief for some homes contracted late in 2017 that close in early 2018.


The actual use of the funds, not the bank's description, determines whether or not a mortgage is deductible. The IRS made clear in a notice last month that homeowners may still deduct interest from a home equity line of credit (HELOC) if the proceeds are used to finance home improvements (such as a kitchen renovation). On the other hand, interest even from a home's main mortgage is not deductible if the proceeds are not used to buy, build, or improve the home. For example, if funds from a mortgage refinance are used for education, the interest on that portion of the debt may not be deducted as mortgage interest.


If an existing mortgage that exceeds the new limit is later refinanced, the interest may continue to be deducted under the old rules to the extent the refinancing does not exceed the existing loan. Thus, the maximum dollar amount that may deducted will not decrease by reason of a refinancing.


Real Estate Tax

The Tax Cuts and Jobs Act provides that for tax years beginning after December 31, 2017, the total amount of the following tax items included in a taxpayer's itemized deductions may not exceed $10,000 ($5,000 for MFS):

  1. State and local property taxes not paid or accrued in carrying on a trade or business, and
  2. State and local income tax (or sales taxes in lieu of income taxes) for the tax year.

Taxes incurred in a trade or business, such as a real estate rental activity, are not subject to this dollar limitation and may be deducted in full (although other limits, such as the passive loss rules, may apply). Foreign income taxes may still be claimed subject to the $10,000/$5,000 limit, but foreign real estate taxes are no longer allowed unless incurred in a trade or business.


Without further action by Congress, all of the above rules expire after 2025, when the rules in effect in 2017 will return. Thus, beginning in 2026, the $1 million mortgage and $100,000 home equity limits will be reinstated and there will be no cap on state and local income or real estate taxes.


In view of these tax changes, we urge you to contact us, particularly if you are considering transactions involving your home (including selling, refinancing, or renting). We would like to assist you with home ownership as it applies to your overall tax plan. Please call your LM Cohen professional for guidance on how these provisions affect you.

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