The new changes in the tax law can cause real headaches for existing homeowners and people who are thinking about buying a home. We highlight five changes resulting from the Tax Cuts and Jobs Act of 2017 as it relates to the mortgage interest deduction and the property tax deduction.
Change #1 New Limit on State and Local Taxes
Under the new rules (as of January 1, 2018), we can only deduct a maximum of $10,000 for all state and local taxes combined. By all state and local taxes combined, we mean the following:
- State and local income taxes (such as state tax withheld from your paycheck)
- Or state and local sales taxes (often useful if your state does not have an income tax)
- Real estate taxes (aka property taxes)
- Personal property taxes (such as vehicle license fees)
This $10,000 cap is the same for single and married taxpayers. Married couples who file separately can deduct a maximum of $5,000 in state and local taxes.
For people living in states with higher than average income taxes or in states with higher than average property taxes (or both), such taxpayers could see a significant reduction in their ability to itemize their state tax expense against their income.
As a practical matter, some clients are accustomed to prepaying in December their property taxes that aren’t due until the Spring of the following year. This strategy might not work going forward. We urge clients to re-evaluate their year-end tax planning moves.
Change #2 Reduction in the Maximum Deductible Loan Amount
Interest paid on a loan secured by your home is deductible against your taxes. But there are limits in place here as well. In fact, there are two limitations.
For new mortgage loans (December 15, 2017 and later), we can deduct interest on the first $750,000 of loan principal. For larger loans, the interest is prorated and the portion attributed to the loan balance above $750,000 is non-deductible. (For married taxpayers who file separately, the limit is $375,000 of loan principal.)
Additionally, the loan proceeds must be spent on buying, building or substantially improving the client’s primary or secondary residence.
Change #3 Previous Mortgage Loans are Grandfathered
If you got your mortgage loan before December 14, 2017, then your loan is grandfathered in. The new $750,000 limit on loan principal does not apply to your loan. Instead, your loan will be subject to the previous limit of $1 million in loan principal. This is the top limit for deducting interest on loans where the funds were spent on buying, building or substantially improving a primary or secondary residence. If your grandfathered loan has a principal balance over the $1 million limit, then interest is prorated over the loan and the portion over it is non-deductible.
Change #4 Refinancing Gets Tricky
If you have a grandfathered mortgage, you can keep the grandfathered status when refinancing the loan. But it’s also possible to lose the grandfathered status. So clients must exercise caution when refinancing.
The following rule applies to home loans where the proceeds were originally used to buy, build, or substantially improve a primary or secondary residence.
You can preserve the grandfathered status as long as the principal amount of the new loan does not exceed the principal amount of the old loan being refinanced. As long as the loan does not increase in size, the refinanced loan will be subject to the old limit of $1 million for deducting interest. If you increase the amount of the loan principal, that additional amount won’t be grandfathered and will be subject to the new $750,000 limit instead.
Change #5 Home Equity Loans No Longer Deductible
Interest on home equity debt is no longer tax-deductible under the new rules found in the Tax Cuts and Jobs Act.
It used to be that we could deduct interest on mortgages where the loan proceeds were not used to buy, build or substantially improve the client’s residence. In tax terms, this is referred to as “home equity debt.” Under the old rules (effective for years 2017 and earlier), we could deduct interest on the first $100,000 of loan principal on such home equity debt.
That has far-reaching implications for clients. For example, it used to be that we could tap into the equity in our home with a loan, and use that loan to consolidate personal debt, or pay for medical expenses, or for college tuition, and write off the interest on our taxes. This kind of tax planning move is no longer possible.
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