Deduction For Interest Paid on Home Equity Debt
A deduction for interest paid on home equity debt is suspended for years 2018-2025. But there is an opportunity to trace the use of the home equity debt to another deductible purpose such as investment or business. How this is accomplished was changed by TCJA. The following explains how it was handled pre-TCJA (and supposedly after 2025 when the suspension of the hone equity debt interest deduction expires) and during the years 2018 through 2025 while the suspension is in place.
Pre-TCJA- Under the pre-TCJA law the interest on up to the first $100,000 of equity debt secured by a taxpayer’s home had to be deducted as “qualified residence interest” (home mortgage interest) regardless of how the funds were used unless the election to unsecure the debt under regulation Section 1.163-10T(o)(5) was made.
CAUTION
If before the passage of TCJA (before 2018) a taxpayer had utilized the unsecured election, that election is irrevocable without IRS consent and thus the loan continues to be treated as unsecured, and since home acquisition mortgage debt is defined as being secured by the home, none of the interest allocated to home acquisition mortgage debt is deductible on Schedule A or anywhere else.
2018 through 2025 - For 2018 through 2025, the interest tracing rules can be applied to ALL debt secured by the home – both home acquisition debt and equity debt – since home equity interest is suspended during that period. That means there is no need to use the unsecured election, since all the interest on a refinanced loan (secured by the home), both home acquisition and excess debt, can be traced to the use of the loan proceeds.
Example – 2018 through 2025: A home has an existing home acquisition debt balance of $40,000 and the taxpayer refinances the home for $200,000. The $40,000 portion of the refinanced debt continues to be home acquisition debt and thus 20% ($40,000/$200,000) x 100)) of the interest on that portion of the refinanced mortgage is deductible on Schedule A. The deductibility of the balance of the interest (80%) depends on (is traceable to) the use of the $160,000 proceeds from the refinance.
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