The new federal tax law created a lot of confusion over whether taxpayers were still able to deduct the interest they pay on their home equity loans and home equity lines of credit.

If you’re planning to redo a bathroom or a kitchen or fix up a fixer-upper, the interest on new home equity loans, home equity lines of credit, and second mortgages will still be deductible, but only up to the maximum amount (for all mortgages) of $750,000. But if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan wouldn’t be deductible.

Example 1: In January 2018, a taxpayer gets a $500,000 mortgage to buy a main home with a fair market value of $800,000. The following month, the taxpayer takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total doesn’t exceed the home’s cost. Because the total amount of both loans doesn’t exceed $750,000, all the interest paid on the loans is deductible. 

Example 2: In January 2018, a taxpayer gets a $500,000 mortgage to buy a main home. The loan is secured by the main home. The following month, the taxpayer takes out a $250,000 loan to buy a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages doesn’t exceed $750,000, all the interest paid on both mortgages is deductible. But if the taxpayer got a $250,000 home equity loan on the main home to buy the vacation home, then the interest on the home equity loan wouldn’t be deductible.

Example 3: In January 2018, a taxpayer takes out a $500,000 mortgage to buy a main home. The loan is secured by the main home. In February 2018, the taxpayer gets a $500,000 loan to buy a vacation home. That loan is secured by the vacation home. Because the total amount of both mortgages is more than $750,000, not all the interest paid on the mortgages is deductible, but a percentage of the total interest paid would be deductible.

Can I still use home equity loans to pay student loans or credit card bills?

Yes. You can use all or part of the loan for personal expenses. You just can’t take the interest deduction on the amount used for those purposes, Ms. Weston said.

How should I document that the money borrowed was used for eligible purposes?

It may be that the I.R.S. will create a new form to go with the interest deduction, on which taxpayers will state the purpose of the loan. Regardless, it’s advisable to keep records and receipts for your home improvement project should you ever need to justify the interest deduction to the I.R.S.

Clergy Financial Resources serves as a resource for clients to help analyze the complexity of clergy tax law, church payroll & HR issues. Our professionals are committed to helping clients stay informed about tax news, developments and trends in various specialty areas.

This article is intended to provide readers with guidance in tax matters. The article does not constitute, and should not be treated as professional advice regarding the use of any particular tax technique. Every effort has been made to assure the accuracy of the information. Clergy Financial Resources and the author do not assume responsibility for any individual’s reliance upon the information provided in the article. Readers should independently verify all information before applying it to a particular fact situation, and should independently determine the impact of any particular tax planning technique. If you are seeking legal advice, you are encouraged to consult an attorney.

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