Acquisition indebtedness is debt incurred to purchase, build, or improve a property. For tax year 2017 and prior, mortgage interest on up to $1,000,000 of acquisition or refinancing of acquisition indebtedness was deductible as an itemized deduction on Schedule A. For any new acquisition mortgage loans after December 15, 2017, this amount is reduced to $750,000. When a refinancing is completed on a mortgage acquired on or before December 15, 2017, and it doesn’t exceed the mortgage that was refinanced, the higher $1,000,000 maximum applies. Additionally, the thresholds above are cut in half for married filing separate taxpayers.
Home Equity Indebtedness
Another type of mortgage interest is home equity indebtedness, which includes debt other than acquisition debt that is secured by a qualified residence. For tax year 2017 and prior, interest on this type of indebtedness, up to $100,000 of debt, is deductible no matter what the proceeds from the loan are used for, as long as the debt didn’t exceed the fair market value of the residence. Beginning in tax years 2018 and ending in the 2025 tax year, this type of interest is no longer deductible unless the proceeds were used to acquire, construct, or substantially improve your home, or when certain elections are in place as discussed further by example below. These new rules apply for all new and existing home equity loans, regardless of when the debt was incurred.
Examples of Deductible Home Equity Interest
Let’s say that you borrow money on your personal residence and use the proceeds for business purposes or to purchase a rental property. Under the new rules the interest paid on this debt would not be deductible as an itemized deduction. However, the taxpayer can make an election under Reg. 1.163-10T(o)(5) (referred to as the 10-T election) to revert to what are called tracing rules. Tracing rules allow a taxpayer to determine the deductibility of the interest on a loan based on the use of the loan proceeds, and would therefore allow the related business interest expenses to be deducted on the appropriate business schedules. The 10-T election only needs to be made in the first year you use the tracing rules, because the election applies to interest paid on that debt for the current year and future years.
If you use proceeds from your home equity line of credit to make improvements to your home, that interest is also still deductible as an itemized deduction.
Example of Non-Deductible Home Equity Interest
If you used your home equity line of credit to pay off credit card debt and to buy a car in 2017, the interest paid on that loan is not deductible beginning in 2018. Additionally, if you use your home equity line of credit for those purposes in 2018, the interest paid on that portion of the loan will not be deductible through 2025. If you used your home equity line of credit for multiple purposes that are both deductible and non-deductible, you will need to allocate the total amount of interest you paid on that loan for the year according to the uses of the funds outstanding.