IRS Clarifies Deductions for Home Equity Loans Are Mostly Unchanged with Tax Reform

The passing of tax reform, commonly referred to as the Tax Cuts and Jobs Act (TCJA), has led to confusion over changes to longstanding deductions—including the deduction for interest on home equity loans.

In response, the IRS issued a statement clarifying the interest on home equity loans, home equity lines of credit, and second mortgages will, in many cases, remain deductible under the TCJA—regardless of how the loan is labeled.

Previous Provisions

Under prior tax law, taxpayers could deduct the interest paid on a loan of up to $1 million for the acquisition of a qualified residence, as long as the loan was secured by the residence. In addition, taxpayers could deduct interest on as much as $100,000 of home equity indebtedness. The home equity debt couldn’t exceed the fair market value (FMV) of the home reduced by the debt used to acquire the home.

For tax purposes, the taxpayer’s principal residence and one additional residence count as qualified residences. These can be houses, condominiums, cooperatives, mobile homes, house trailers, or boats with living facilities.

The principal residence is where the taxpayer resides most of the time, and the second residence is any other residence the taxpayer owns and treats as a second home. Taxpayers aren’t required to use the second home during the year to claim the deduction.

In the past, interest on the $100,000 qualifying home equity debt was deductible regardless of how the loan proceeds were used. A taxpayer could, for example, use the proceeds to pay for medical bills, tuition, vacations, vehicles, and other personal expenses and still claim the itemized interest deduction.

New Rules Under the TCJA

The TCJA limits the mortgage interest deduction amount for taxpayers who itemize through 2025. Beginning in 2018, a taxpayer can deduct interest only on acquisition debt of up to $750,000.

The TCJA also suspends the deduction for interest on home equity debt, states the congressional conference report on the law. And the bill includes the section caption, “Disallowance of Home Equity Indebtedness Interest.” As a result, many people believed the TCJA eliminated the home equity loan interest deduction.

However, the IRS issued a release (IR 2018-32) on February 21 explaining that the law only suspends the deduction for interest on home equity loans and lines of credit that aren’t used to buy, build, or substantially improve the home that secures a taxpayer’s loan.

In other words, the interest isn’t deductible if the taxpayer uses loan proceeds for certain personal expenses, but it’s deductible if the proceeds go toward, for example, a new roof on a qualified residence. The loan must be secured by the home for which the improvements are made and the combined debt on the home can’t exceed its value.

The IRS further stated that the deduction limit of interest on $750,000 of home mortgage debt applies to the combined amount of mortgage and home equity acquisition loans on both qualified residences. This means that home equity debt is no longer capped at $100,000 for purposes of the deduction, but is subject to a larger overall qualified residence debt of $750,000.


IR-2018-32 includes examples to help show how the TCJA rules work. The following cover three different scenarios.

Example One

A taxpayer takes out a $500,000 mortgage to buy a principal residence with an FMV of $800,000 in January 2018. The loan is secured by the residence. In February, he takes out a $250,000 home equity loan to pay for an addition to the home. Both loans are secured by the principal residence, and the total doesn’t exceed the value of the home.

The taxpayer can deduct all of the interest on both loans because the total loan amount doesn’t exceed $750,000. If he used the home equity loan proceeds to pay off student loans and credit card bills, the interest on that loan wouldn’t be deductible.

Example Two

The taxpayer from the previous example takes out the same mortgage in January. In February, he also takes out a $250,000 loan to buy a vacation home, securing the loan with the new home. Because the total amount of both mortgages doesn’t exceed $750,000, he can deduct all of the interest paid on both mortgages.

But, if he took out a $250,000 home equity loan on the principal home to buy the second home, the interest on the home equity loan wouldn’t be deductible.

Example Three

In January 2018, a taxpayer took out a $500,000 mortgage to buy a principal home, secured by the home. In February, she takes out a $500,000 loan to buy a vacation home, securing the loan with that home. Because the total amount of both mortgages exceeds $750,000, she can deduct only a percentage of the total interest she pays on them.

We’re Here to Help

The new IRS announcement highlights the fact that the nuances of the TCJA will take some time to completely come to light. We’ll keep you updated on the most significant guidance and new rules as they emerge.

If you’d like to learn more about how the new tax laws will impact you, contact your Moss Adams professional. You can also visit our dedicated tax reform page to learn more.

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