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Do you have a line of credit or planning to take one?  Not sure about the impact of the tax plan on home equity loans, home equity lines of credit (HELOC), and second mortgages?

Citing the “many” questions it received, the Internal Revenue Service issued a bulletin last week that clarifies how these loans will be treated under the new tax plan.

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According to the IRS bulletin, the interest paid on home equity loans and lines of credit (HELOC) is still deductible, as long as the money is used to “buy, build or substantially improve” the taxpayer’s home that secures the loan in question.

But if the money is used to pay other expenses, the interest is not deductible.

The IRS goes on to explain: “Under the new law, for example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not,” the IRS stated. “As under prior law, the loan must be secured by the taxpayer’s main home or second home (known as a qualified residence), not exceed the cost of the home and meet other requirements.”

Note that the maximum loan amount for which interest can be deducted is $750,000. That is for first and second mortgage combined for all residences (primary and vacation/second homes). The mortgage interest deduction limit for a married taxpayer filing a separate return is $375,000.

These figures are down from the previous limits of $1 million, or $500,000 for a married taxpayer filing a separate return.

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The IRS bulletin provides three examples to further demonstrate how the mortgage interest deduction works now:

  • Example 1: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000. In February 2018, the taxpayer takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total does not exceed the cost of the home. Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible. However, if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan would not be deductible.
  • Example 2: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $250,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages does not exceed $750,000, all of the interest paid on both mortgages is deductible. However, if the taxpayer took out a $250,000 home equity loan on the main home to purchase the vacation home, then the interest on the home equity loan would not be deductible.
  • Example 3: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $500,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. A percentage of the total interest paid is deductible.
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