Taxpayers get good news on HELOCs

It’s official: Despite widespread fears to the contrary, the IRS has clarified that last year’s big tax bill did not kill all interest deductions on home equity lines of credit (HELOCs) and equity loans.

In a policy statement, the IRS said that it has received “many questions … from taxpayers and tax professionals” about HELOCs and equity loans in the wake of the Tax Cut and Jobs Act of 2017, which passed in December. That legislation eliminated a section of the federal tax code authorizing interest write-offs on “home equity indebtedness” from 2018 through 2025. But as noted in this column in January, the law did not curtail deductions on all HELOC and equity loan interest payments. It depends on how you use the money you borrow.

Taxpayers can “often still deduct interest on a home equity loan, home equity line of credit or second mortgage, regardless of how the loan is labeled,” said the IRS, provided the borrowed funds are used to “buy, build or substantially improve the taxpayer’s home that secures the loan” and the total debt on the house does not exceed statutory limits. The amount of the first mortgage on the property, combined with the home equity or HELOC debt, cannot exceed $750,000, the newly revised limit for mortgage interest deductions by taxpayers filing joint returns; married owners filing separately have a new ceiling of $375,000. Previously, the limits were $1 million and $500,000.

So what does all this mean in practical terms? Here’s a quick example. Say you and your spouse own a $500,000 house and have a $250,000 first mortgage with an interest rate in the mid-3-percent range. You want to put on a family room addition estimated to cost $100,000 and do bathroom upgrades estimated to run another $50,000. However, you’d prefer not to give up your super low interest rate by refinancing into a new, larger first mortgage. Another option, now fully sanctioned by the IRS: Take out a $150,000 HELOC that will permit you to draw down periodic amounts to pay contractors as they complete scheduled construction benchmarks, leaving your first mortgage intact.

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Since 100 percent of your HELOC dollars are to be used to substantially improve your home — and the combined debt load of $400,000 ($250,000 plus $150,000) is well below the statutory limit and doesn’t exceed the value of your home — you should be able to write off all the interest on your HELOC.

In its policy statement, the IRS offered examples of what you cannot do with your HELOC or home equity loan cash if you want to write off the interest. At the top: paying off credit card bills and other personal debts. This is potentially a big deal for some owners because, in past years, debt consolidation — rolling credit card balances and other high interest rate personal expenses together into a single, lower-cost loan — was an important financial strategy for many families. You can still do debt consolidations with equity loans — you just can’t write off the interest. Another major use that is now cut off from interest deductions when using home equity dollars: paying off student loans.

Though the IRS didn’t specify them, other once-popular uses for equity cash that no longer will qualify for write-offs are auto purchases, vacation travel expenses and buying home furnishings. All these were commonplace during the heyday home equity borrowing binge years of 2004-2006, just before the market came tumbling down.

Some good news: You don’t have to spend 100 percent of your HELOC cash on home improvements, according to Greg A. Rosica, a tax partner with Ernst & Young, the national accounting firm. You can buy or do other things with the money — you just can’t deduct the interest you pay on them. Quick example: Say you own a $500,000 house with a $300,000 first mortgage. You borrow $100,000 via a HELOC this year. You spend $80,000 on a new roof and master bath. You spend the other $20,000 on paying off student loans. Under IRS allocation rules, you can still write off interest on the $80,000 you spend on home improvements — four-fifths of the total. Interest payments on the student loans are not deductible.

Bottom line: Americans’ home equity just hit a record $14.1 trillion, according to the Federal Reserve. So there’s plenty of cushion that could be tapped for responsible purposes — whether homeowners choose to deduct the interest or not.