For those individuals who itemize on their federal income tax return (that is, they file Schedule A of Form 1040), one of the most often used itemized deductions is the home mortgage interest deduction. This column explains the home mortgage interest deduction and its limitations.
It is important to mention that the Tax Cuts and Jobs Act of 2017 (TCJA) resulted in significant changes to the home mortgage interest deduction. These changes are discussed in this column.
TCJA repealed the deduction for home equity line interest for the period beginning Jan. 1, 2018 and ending Dec. 31, 2025. There is no “grandfathering” of existing home equity loans that were in effect before Jan. 1, 2018. The only exceptions to this repeal are home equity loans, lines of credit, or second mortgages used to buy, build or improve an individual’s home (the individual’s principal residence) that secures the loan.
The TCJA also changed the limit on the amount of the mortgage interest deduction on new mortgage loans, refinanced additional mortgage loan borrowings and extended mortgage loans to the first $750,000 ($375,000 if married filing separate) of debt for new or modified loans taken out after Dec. 31, 2017.
There are three tests that must be met by a homeowner in order to deduct on his or her federal income tax return (Schedule A) the home mortgage interest paid during the year.
These tests are:
Advertisement
(1) The home must be secured by the loan;
(2) the home must be the individual’s main home or second/vacation home; and
(3) the individual must have an ownership interest in the home.
Mortgage interest paid on both a primary home and a second/vacation home (in total and not individually) residence may be deducted in one-year subject to the following limits:
• Up to $1 million in “acquisition” debt (to buy, build or improve the home) incurred before Dec. 15, 2017, or $750,000 for loans extended, increased or originated after Dec. 14, 2017.
• To be considered “acquisition” debt, the mortgage loan must be secured by the same home used as equity to borrow the money. This means if an individual borrows against one’s primary home in order to buy a second/vacation home and therefore the loan proceeds are not used to buy, build or improve the secured home (that is, the primary home) the mortgage interest paid is not deductible. The following example illustrates:
Example. Tom and Melissa had $700,000 of outstanding mortgage debt on their home on Dec. 13, 2017, with 24 years remaining on their 30-year fixed-rate mortgage. On Jan.6, 2018 they refinanced the balance.
• If they refinance the existing mortgage for $700,000 (in order to obtain a lower interest rate) over 24 years or less, then the entire amount of mortgage interest paid is “grandfathered” and fully deductible.
• If they refinance for $800,000 over 24 years or less and do not use the extra $100,000 ($800,000 less $700,000) to improve their home, the interest paid on the first $700,000 loan will be “grandfathered” and fully deductible, while the interest on the excess $100,000 will be nondeductible, without regard to the home’s original cost. An individual may not “grandfather” acquisition debt greater than the original acquisition debt.
• If they refinance $800,000 over more than 24 years, the TCJA will limit the mortgage interest on up to $750,000. This is because effective Dec. 15, 2017, qualified acquisition debt on a primary residence is limited to $750,000. The interest paid on the excess $50,000 ($800,000 less $750,000) is nondeductible.
It is important to mention that among the items included in the Highway Bill passed by Congress in 2015 is a provision that requires that effective Jan. 1, 2017, that Form 1098 (Mortgage Interest Statement) (the form reports to homeowners the amount of mortgage interest paid) will include:
(1) the end of year outstanding mortgage balance;
(2) the mortgage origination date; and
(3) the address or description of property securing the mortgage.
The following is a copy of Form 1098. Note boxes 1,2,3 and 8.
A home mortgage is any loan that is secured by a main (principal residence) home or a second/vacation home. This includes first and second mortgages, home equity loans and refinanced mortgages. Note the following:
• To deduct the mortgage interest, an individual must be legally liable on the mortgage
• Homes under construction are considered qualified homes for purposes of the “acquisition indebtedness” for a period of up to 24 months. This is the case provided it becomes an individual’s qualified home when it is ready for occupancy. The 24-month period starts any time on or after the day construction begins.
A secured debt is a debt in which a borrower signs an instrument (such as a mortgage, deed of trust or land contract) that:
(a) Makes ownership in a qualified home security for payment of the debt;
(b) provides in case of default that the home could satisfy the debt; and
(c) is recorded under any state or local law that applies. In other words, if a home is collateral for the loan, then the loan (mortgage) is considered secured debt.
Interest payments made on behalf of others (for example, to “help out the kids”) are not deductible by the payer. This is because the payer is not obligated on the debt and is not deductible by the individual who is obligated on the debt. This is because the latter did not make the payment.
Finally, the following should be noted:
• Late payment charges usually qualify as deductible interest
• Mortgage prepayment penalties usually qualify as deductible interest, and
• Interest prepaid for a future year is not deductible in the current year.
