One of the most highly touted benefits of homeownership has traditionally been the write-offs homeowners can claim to reduce their federal income tax bills. However, the Tax Cuts and Jobs Act (TCJA) of 2017 cuts back on deductions for many homeowners – and some homeowners may no longer get any bang for the buck when it comes to the cost of homeownership. Here’s a rundown of what’s still deductible— and what’s not—under the new tax law.
Home Mortgage Interest
Homeowners can claim an itemized deduction for “qualified residence interest” paid on debt secured by a primary residence and one other residence.
In the case of “acquisition indebtedness” incurred to buy, build or substantially improve a home, prior law limited the deduction to the interest on $1 million of debt ($500,000 for married individuals filing separately). Effective for tax years beginning after 2017 and before 2026, the new law cuts the deduction back to the interest on $750,000 of acquisition debt ($375,000 for married individuals filing separately).
KEY POINT: The $750,000 debt limit generally applies only to new homeowners. The $1 million acquisition debt limit continues to apply to acquisition debt incurred before Dec. 15, 2017. Moreover, the $1 million dollar limit will apply to homeowners who entered into a written binding contract before Dec. 15, 2017, to close on a principal residence before Jan. 1, 2018, and who actually purchased the residence before April 1, 2018. A refinancing of acquisition debt incurred before Dec. 15, 2017, will continue to be subject to the $1 million limit, provided the refinancing doesn’t exceed the amount of the original debt.
Home equity debt is a different story. Under prior law, taxpayers could deduct the interest on up to $100,000 of home equity indebtedness ($50,000 for married individuals filing separately). For 2018 through 2025, the new law eliminates all deductions for interest on home equity debt, regardless of when the debt was incurred.
KEY POINT: The fact that a debt is called a home equity loan or home equity line of credit does not automatically mean the interest is nondeductible. It’s the use of the loan that matters. If the proceeds of a loan are used to buy, build or substantially improve, it will be treated as acquisition debt, even if the loan is labeled a home equity loan.
For example, a homeowner has an existing $500,000 mortgage on his home. In 2018, the homeowner takes out a $250,000 home equity loan to build an addition on the home. Both loans are secured by the home, and the total does not exceed the fair market value of the home. Because the total of the two loans does not exceed $750,000, all of the interest paid on the loans is deductible in 2018.
Historically, property taxes paid on a home have been deductible without limit. However, for tax years 2018 through 2025, the TCJA places a $10,000 ($5,000 for married filing separately) limit on aggregate deductions for state and local taxes, including property taxes.
KEY POINT: As critics of the new law have pointed out, the cutback in state and local tax deductions will be felt the hardest in states with high income and property taxes, including California and New York. However, state and local taxes are an alternative minimum (AMT) tax adjustment, and many taxpayers lost the value of the deduction if they paid AMT in the past. To the extent state and local taxes apply to the taxpayer’s business, folks should remember to deduct those taxes on Schedules C, E or F and not on Schedule A. Also, when buying or selling a home, taxpayers can consider negotiating who covers the real estate taxes.
Extender Provisions Going Away in 2018
Mortgage insurance premiums: Under prior law, there was an itemized deduction for the amount you paid for mortgage insurance, which was considered interest for mortgage interest deduction purposes. Taxpayers can consider asking the mortgage company to drop the insurance if they have made timely payments for several years or possibly refinancing the loan altogether.
Energy-related home improvements: Under prior law, homeowners who made energy efficient improvements to their homes, including energy-saving roofs, windows, skylights and doors, could claim a credit for 10 percent of amounts paid for qualified energy efficiency improvements and 100 percent of amounts paid for qualified energy property, including high-efficiency water heaters, air conditioning units, and furnaces for the taxpayer’s principal residence. Going forward, homeowners can still take a credit for solar electric and solar water heating type improvements.
The Standard Deduction Effect
Under both prior and current law, homeowners benefit from home mortgage interest and property tax deductions only if they itemize deductions – and then only to the extent their itemized deductions exceed the standard deduction.
For 2018, the new law nearly doubles the standard deductions to $24,000 for joint filers and surviving spouses, $18,000 for heads of households, and $12,000 for single taxpayers and married individuals filing separately – up from $13,000 for married couples filing jointly and surviving spouses, $9,550 for heads of households, and $6,500 for single individuals and married individuals filing separately.
KEY POINT: The increased standard deductions coupled with the cutbacks in itemized deductions will mean that many taxpayers will no longer benefit from itemizing their deductions. Moreover, taxpayers who continue to itemize will see the tax benefits over and above the standard deduction reduced. The higher standard deduction may also provide a planning opportunity for taxpayers to bunch deductions and itemize every other year to increase their deductions over a two-year period.