By: Dave Perkins, J.D., CPA, CFP®
It used to be simple. If you needed a ready source of tax-deductible cash, you tapped the equity in your home. School tuition due? Draw on the home equity line of credit and deduct the interest. Interest rate lower on the equity line than your car loan? Borrow against the house, pay off the car loan and deduct the interest. But those ideas don’t work anymore under the new tax law.
There are three types of interest that may be deductible under the new rules: Home Equity loans, mortgages, and investment interest. For any home equity line of credit (HELOC) interest to be deductible, the loan must be used for home improvements, and the HELOC must be secured by the house on which you made the improvements. And any home equity loans you might have had outstanding at the end of last year were not “grandfathered”. In other words, you have to satisfy the new rules or that interest is not deductible.
The rules for regular mortgages have also changed. The limit is now $750,000 – reduced from $1 million – for mortgages on which you can deduct the interest. And to qualify, the mortgage has to be secured against the house for which the money was borrowed to buy the house or to make improvements. So if your principal home has no debt and you borrow against it to buy that place at the lake – the interest would no longer be deductible.
One bit of good news that applies to mortgages (but not to home equity loans) – loans that were already in place before the law was changed remain deductible up to $1mm rather than the new $750,000 limit. And if you already had a mortgage in place against your principal residence that was used to buy a second home, that interest also remains deductible if it was in place before the law was changed.
Investment interest expense remains deductible under the new law. These are loans called margin loans or collateral loans typically borrowed against a non-IRA investment account and used to make other investments. But the mere fact that the money was borrowed against an investment account does not automatically allow the interest to be deductible. What matters to the IRS is how the money from the loan was used – what they call the “Tracing Rule”. Trace how the cash was used to determine if it can be deducted as investment interest. If you borrow against an investment account but use the money to pay college tuition – no deduction. If you borrow against the investment account and use the money to buy a personal lake house – no deduction. If you use the cash borrowed against your portfolio to make more investments in stocks, bonds, real estate, etc., the interest can be deducted as investment interest.
Keep in mind one other important rule about investment interest. It can only be deducted up to the amount of your “investment income”, which typically means only your taxable interest income and your non-qualified dividends. No deduction is allowed against capital gains or qualified dividends because those are already taxed at a lower rate than regular income, nor against municipal bond interest that isn’t taxed at all.
Business loans remain deductible. Again, follow the Tracing Rule. Whether you borrowed using a HELOC, a margin loan or a credit card, if the money can be shown to have been used in your business, it remains deductible. And keep in mind that interest expense allocated to your home office would also be deductible since that is business activity.
No, it’s not as simple as it was, but with a little bit of thought your interest expense may still qualify for tax deductibility.
Dave Perkins is a Consultant & Financial Planner with Carolinas Investment Consulting. He has 30 years of practical, detailed financial experience in the objective advice business, having worked variously as an attorney, CPA, Certified Financial Planner™, and Fee-Based Investment Consultant. Click here to learn more about how Dave can help you. David A. Perkins, CPA is a licensed North Carolina CPA firm. Although Dave provides his financial planning and investment consulting services through Carolinas Investment Consulting, it is a separate business from his CPA practice and bears no legal responsibility for tax advice provided by Dave in his capacity as a CPA.
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