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The Change to Personal Mortgage Interest Deductions and How It Will Impact Your Borrowers

Aug 27, 2018

The Tax Cuts and Jobs Act (TCJA) resulted in more tax law changes than any tax bill since 1986. Signed into law on December 22, 2017, TCJA has kept many people busy evaluating the impact on individuals and businesses and helping to proactively plan around these changes. One specific change in TCJA was the deduction for personal mortgage interest. As you help your borrowers, you should be careful to give accurate information on the deductibility of personal mortgage interest under TCJA.


Before TCJA, mortgage interest paid on mortgages used to buy, construct, or improve a taxpayer’s first or second home was allowed as an itemized deduction, but the deduction was limited if the principal balance exceeded $1 million. Mortgage interest on home equity debt was also an itemized deduction, but that deduction was also limited if the principal balance exceeded $100,000. Many homeowners itemized deductions, saving income taxes by deducting their mortgage interest. The percent of taxpayers that itemized deductions increased based on adjusted gross income (AGI): In 2016, 21% of taxpayers with AGI between $30,000 to $50,000 itemized, whereas 92% of taxpayers with AGI between $200,000 and $250,000 itemized.1 


Under TCJA, the mortgage interest deduction as new, stricter limits. Instead of the $1 million mortgage principal and $100,000 home equity principal thresholds stated above, TCJA moved these thresholds to $750,000 and $0, respectively. For mortgages taken out before 12/16/17, or under a binding contract before 12/16/17 and closed before 4/1/18, the $1 million principal threshold still applies. If such mortgages are later refinanced, they too maintain the $1 million threshold up to the amount of the principal balance of the old, grandfathered loan at the time of refinance (additional principal added on the refinanced loan does not qualify for the $1 million threshold). The separate threshold for deducting interest paid on home equity debt is gone beginning in 2018; there is no grandfathering for these loans.


Despite losing the separate tax deduction threshold for interest paid on home equity debt, there may still be some ability to deduct home equity debt interest. For this deduction, it is important to understand how “acquisition” and “home equity” indebtedness is defined for tax purposes. Acquisition indebtedness is defined as any debt incurred in acquiring, constructing, or substantially improving a qualified residence (for example, if a customer takes out a home equity loan and uses the proceeds to remodel their kitchen, the interest on this debt will be tax deductible as acquisition indebtedness). On the other hand, home equity indebtedness is defined as indebtedness other than acquisition indebtedness (for example, if a customer takes out a home equity loan and uses the proceeds to purchase a car, the interest on this debt will not be tax deductible). The borrower will ultimately be responsible for determining whether their mortgage debt is “acquisition” debt or “home equity” debt. The TCJA $750,000 principal threshold applies to the combined principal of qualified mortgages (unless grandfathered mortgage limits apply) and “acquisition” home equity debt. 


The change to mortgage interest deductions is only one small change regarding itemized deductions. Under TCJA, the number of taxpayers that itemize will decrease for several reasons. The standard deduction was increased from $6,350 (single)/$12,700 (MFJ) to $12,000 (single)/$24,000 (MFJ). That alone may cause borrowers to no longer itemize since the standard deduction may be higher than their itemized deductions. In addition to the standard deduction increase, TCJA also puts a new limitation on itemized deductions allowed for state and local taxes, which includes state and local property taxes such as real estate taxes, and state and local income taxes (or sales tax if elected). There was no limitation prior to TCJA, but TCJA limits the amount of this component of itemized deductions to just $10,000 going forward. 


This leaves $14,000 of other itemized deductions needed by MFJ taxpayers before they would itemize. Note that taxpayers subject to the alternative minimum tax (AMT) have itemized deductions for state and local taxes disallowed for AMT purposes; this AMT disallowance has not changed. TCJA made other changes to itemized deductions that are not discussed here. 


The number of taxpayers that will itemize in 2018 is expected to be less than 11% overall.2 High-income taxpayers make up most of the taxpayers expected to itemize under TCJA, which means many borrowers will no longer itemize deductions going forward.


Knowing about these changes can allow for opportunities to maximize your borrowers’ tax deductions. Here are just a few ideas related to personal mortgage interest:

  • If the borrower is contemplating home equity debt and using the proceeds for acquiring, constructing, or substantially improving a qualified residence (for example, a kitchen remodel), the borrower may get a tax deduction if they itemize deductions. Documentation should be maintained by the borrower to show how the proceeds were used to support a tax deduction.
  • If the borrower has home equity debt used as a student loan, it may be more advantageous to have a student loan since that interest, up to $2,500 depending on income thresholds, may be tax deductible.
  • If the borrower has/needs a personal mortgage and/or a student loan, but the borrower will not itemize under TCJA, it may be more advantageous to have student loan debt since student loan interest may be deductible, up to $2,500 depending on income thresholds.


As you meet with borrowers and potential borrowers, be careful how you address the tax deductibility of personal mortgage interest. If you are unsure, we recommend that you consult with Wipfli or have your borrower consult with their tax advisor.


Note that for filing status other than single and MFJ, other limits may apply. Those are not addressed in this article. In addition, if mortgage interest relates to rental property, business property, home office, etc., there may be tax deduction opportunities outside of the itemized deductions described in this article.