Before the TCJA, taxpayers could deduct interest paid on up to $1 million ($500,000 if married filing separately) of home acquisition debt (debt used to buy or substantially improve a first or second home). Also, taxpayers could deduct interest paid on up to $100,000 ($50,000 if married filing separately) of home equity debt, regardless of how the proceeds were used.
The TCJA cuts those numbers back significantly. For 2018–2025, the TCJA reduces the limit on home acquisition debt to $750,000. For married taxpayers filing separately, the debt limit is halved to $375,000. Also, the TCJA generally disallows home equity debt interest. However, the IRS recently advised homeowners that interest paid on home equity loans and lines of credit may be deductible if the funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan. In other words, such loans will be treated as home acquisition debt subject to the new $750,000/$375,000 limits.
Thanks to a set of grandfather rules, the new limits don’t apply to home
acquisition debt that was taken out on or before 12/15/17 (or taken out on or before that date and refinanced later). This is good news for existing homeowners. However, if you have a home equity loan or line of credit, we will need to trace how the proceeds were used to determine if the interest is still deductible under the new law.
In addition, it may be beneficial to refinance your home using an interest-only mortgage. For example, if you refinance $1 million of pre-TCJA home acquisition debt with a new $1 million interest-only loan, you can continue to deduct all the interest under the grandfather rules. In contrast, if you gradually make principal payments on your $1 million of pre-TCJA home acquisition debt, you won’t be able to treat any portion of an additional home loan taken in 2018–2025 as home acquisition debt because your existing loan will absorb the entire $750,000 TCJA limit.