The tax code and your bank might disagree on whether or not you have a home equity
loan, and the difference could reduce your taxes.
The Tax Cuts and Jobs Act eliminated home equity interest deductions on individual tax returns for years after December 31, 2017. It doesn’t matter when the loan was taken out. You can’t deduct home equity mortgage interest as an itemized expense on tax returns for years after 2017.
But the tax code has its own definition of home equity interest.
The code divides home mortgages into two types. There is an acquisition mortgage, which is a mortgage to buy, build, or substantially improve your home. A home equity loan is any mortgage that isn’t an acquisition mortgage.
So, if you took out a mortgage to “substantially improve” your home, it is acquisition indebtedness. That’s true even if you already had a first mortgage or the lender calls it a home equity loan. Under the tax code, it’s the use of the mortgage proceeds that determines whether it is an acquisition loan or a
home equity loan.
The advantage of having a loan qualify as acquisition indebtedness is that the interest is deductible when it is attributable to principal up to $750,000. If the loan isn’t acquisition indebtedness, the interest isn’t deductible.
Under the IRS rules, a home improvement is substantial when it adds to the value of the home, prolongs its useful life, or adapts the home to new uses. A good rule of thumb is that any expenditures that maintain your home in good condition aren’t substantial improvements. Having the home repainted
usually isn’t a substantial improvement. That’s normal maintenance that sustains the value and keeps the home in good condition. But an expansion or renovation of the home can qualify as a substantial improvement, especially if it increases the home’s value.
If you have any doubts, you can review free IRS Publication 939, available at www.irs.gov, or discuss the issue with a tax advisor.
Mortgage interest is deductible on a principal residence and a second home. But the $750,000 mortgage limit is per taxpayer, not per home. Also, for the interest to be deductible, some other conditions must be met. The loan must be secured by the home, and that security interest must be recorded as required
by local law. Any home or part of the home that is used as a rental unit or for business purposes doesn’t qualify for the itemized expense deduction. (The interest attributable to it could be deductible
elsewhere on the tax return.)