There continues to be much confusion around the impact of the new tax law on home equity lines of credit and home equity loans. While bankers should not be providing tax advice as taxpayers should be consulting with their own professional advisor, WBA realizes it is helpful for bankers to have a general understanding of the impact their loan products have on borrowers to not only answer general questions but also to guide bank product development and marketing strategies. This article will attempt to explain the tax law changes as it relates to home equity loans.
The general rule for taxpayers itemizing deductions is that effective for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, the Tax Cuts and Jobs Act (TCJA) no longer allows a deduction for interest on home equity debt regardless of when the home equity debt was originally incurred, and regardless of the lien position of the home equity debt. In other words, there is no grandfathering treatment for existing home equity loans and the rules apply whether the loan is a first, first-lien equivalent, or true second mortgage on a principal residence and/or second home. For taxpayers who will not benefit from itemizing deductions under the new law, this analysis is inapplicable.
The only important exception to this general rule for home equity debt is if the purpose of the debt qualifies under the tax code as “acquisition indebtedness.” Under the tax code, acquisition indebtedness of a principal residence and/or second home is debt that is incurred in acquiring, constructing, or substantially improving a qualified residence. “Qualified residence” is also a defined term under the tax code but generally includes the taxpayer’s principal residence and one and one other residence of the taxpayer. Acquisition indebtedness also includes indebtedness from the refinancing of other acquisition indebtedness, but only to the extent of the amount of the refinanced indebtedness. It is the responsibility of the taxpayer, not the bank, to keep track of debt that is acquisition indebtedness compared to debt that is for other purposes.
Under the new law, the aggregate amount a taxpayer may treat as acquisition indebtedness can’t exceed $750,000 ($375,000 for married persons filing separately). Any acquisition debt (whether a traditional closed-end mortgage or home equity debt qualifying as acquisition indebtedness) incurred on or before Dec. 15, 2017 is instead subject to the $1,000,000 ($500,000 for married persons filing separately) acquisition debt limit. Note that in applying the $750,000/$375,000 acquisition debt limit to any indebtedness incurred after December 15, 2017, the $750,000/$375,000 limit must be reduced (but not below zero) by the amount of any indebtedness incurred on or before December 15, 2017 that is treated as acquisition indebtedness for purposes of the qualified residence interest (QRI) deduction for the tax year.
As an example, assume a taxpayer had a first mortgage of $150,000 of which $100,000 was from refinancing the original acquisition mortgage and $50,000 was cash taken out for college costs. The $100,000 would be acquisition debt and the $50,000 would be home equity debt. Assume that same taxpayer also took out a $25,000 home equity line of credit for the sole purpose of remodeling the kitchen. That debt would qualify as acquisition debt because it is for the purpose of improving a qualified residence. In this example, the total acquisition debt would be $125,000 – the portion of the mortgage loan used for acquisition and the home equity line of credit. The interest on the portion of the mortgage loan ($50,000) that was used for college costs would be nondeductible. Tracing rules apply that consider the least advantageous debt to be paid off first, so principal on the first mortgage would be applied to the home equity portion first.
Again, it is important to not give your customers tax advice as often bankers do not know how debt proceeds, particularly home equity debt proceeds, are spent by borrowers. It is expected that the IRS will issue guidance on this and other aspects of the TCJA.
NOTE: While the likelihood is small, it is possible the IRS guidance document will incorporate or interpret items in a way that is unexpected. WBA will inform the membership as such guidance is published.
Oswald Poels is WBA president and CEO.