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If you use a home equity loan or home equity line of credit to buy, build or improve your main residence or second home, the new tax law allows you to deduct up to $100,000 in interest on those loans, the Internal Revenue Service says.
The IRS this week clarified a provision of the Tax Cuts and Job Acts that eliminates the deduction for interest paid on home equity loans and lines of credit. After receiving questions from taxpayers and tax preparers concerned that there was a blanket elimination of the deduction, the IRS has made it clear that the deduction is not allowed only if the money is used for something other than to purchase, build or substantially improve a home.
For example, if a homeowner uses an existing home equity loan or home equity line of credit or takes out a new one to pay student debt, buy a car or reduce credit card balances the interest isn’t deductible. This rule will take effect for the taxes homeowners file in 2019.
Home equity loans and lines of credit were originally designed to help property owners renovate and expand their homes. But they’ve grown in popularity as a way to borrow money for other purposes. The expanded use of these loans began in 1986, when the last major overhaul to U.S. tax code eliminated write-offs for interest on credit cards, auto loans and other consumer debt.
John Lieberman, a New York City certified public accountant, says more than half his clients use home equity loans to help buy or renovate their primary residences or second homes. “There was a lot of concern that these were no longer deductible for those purposes,’’ he says.
There are limits on the amount of home equity loan and lines of credit interest that can be deducted because the new tax law caps the total amount of home-related interest that can be written off. Interest on mortgage debt up to $750,000 can be deducted on homes purchased after Dec. 15, 2017. Homeowners who bought before then can still deduct the interest on mortgage debt of up to $1 million.
For example, if a taxpayer buys a home this year with a $500,000 mortgage, then takes out a $250,000 home equity loan for an addition and the home is used as collateral to secure both loans, the interest paid on the combined $750,000 in debt is deductible.