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Expert Mortgage Interest Deduction Tricks for 2018 Savings

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Expert Mortgage Interest Deduction Tricks for 2018 Savings

Is it for real estate or for personal?  That is the question.  If you are used to using your home equity line of credit (“HELOC”) as a personal “piggy bank” and taking the interest as a deduction, then 2018 could be a rude awakening.  Under the Tax Cut & Jobs Act (“TCJA”), this deduction is no longer available.  Or is it?  It turns out that the TC&JA is making a distinction between home mortgage indebtedness used for a mortgage and home mortgage indebtedness used for other purposes (i.e., paying down credit cards, student loans, or for personal purchases).  A simple rule of thumb is that if you are using your home equity loan as a “piggy bank” to fund your lifestyle and pay for consumer goods, you are out of luck; but, if you are using your home equity loan for repairs, additions, or to cover the cost of the home, you are in luck.  What about financing your children’s education and/or college tuition with a home equity loan?  No Bueno.  IRS’s own guidance indicates that deducting the mortgage interest on a HELOC will still be available for most taxpayers. See IR 2018-32

The IRS is trying to reign in abuses and prevent incentivizing high-interest purchases put on the house’s tab.  The limit on qualified residence loans is down, however, from $1,000,000 to $750,000.  Unlike the principal residence mortgage deduction, which is grandfathered in at the old rate of $1,000,000 if you purchased before Dec. 15, 2017, the home equity mortgage deduction doesn’t have a grandfathering provision.  Haven’t made much progress on your mortgage and have a “jumbo” loan approaching $1,000,000 or over the $1,000,000 Maginot line?  Good news.  You can sill re-finance that loan and probably continue to deduct the full $1,000,000, but there are a thicket of tricky rules to weed through, such as, for instance, you cannot extend the term beyond 30 years.

So, what should you do?

Smart Taxpayer Move #1:

A good move would be to re-finance and collapse your HELOC into your first mortgage.  This eliminates all doubt as to the deductibility of your mortgage interest as long as the total loans you are deducting interest on are less than $750,000.  If higher, you will be limited to the proportional deduction based on $750,000 of interest bearing debt.

Smart Taxpayer Move #2:

You could make “extra” mortgage payments.  But, be careful!  If you just send extra payments in to the bank, they will generally default to applying these strictly to principal, which will not give you any additional deduction!  So, to get extra deductions for couples who are otherwise capped out by the individual deduction (see below), you will have to talk to your bank.  You need to clearly instruct the bank to apply the payment to any accrued interest, thus making the entire payment tax deductible.  One way to look at it is the way a financial advisor would.  Let’s say you have $1.  That $1 is worth .63 cents after tax assuming a 37% top tax rate.  You could invest that dollar and earn a 4% return on investment before paying your taxes, in which case, you netted .67, assuming you defer capital gains.  On the other hand, if your mortgage interest rate is 4%, you could also make extra mortgage payments, netting you an automatic 4% return on investment and reducing your tax liability by 1.2%, once you are over the standard deduction cap.  That means you netted .722.  Smart!!!

But, wait, will the increase in the standard deduction to $12,000 for individuals and $24,000 for couples effectively make my home mortgage deduction superfluous?  Possibly so.  If you are married and your mortgage is $550,000 or less, which equates to a $23,800 deduction, you are phased out unless you have other qualifying deductions.  This is because the standard deduction is higher.  Obviously, this will be the case for the vast majority of homeowners with traditional mortgages.

What about property taxes?  In 2018, your state and local property taxes are limited to $10,000 if you itemize, so be careful and plan ahead.

Category: Tax

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