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Is Mortgage Interest Still Deductible After Tax Reform?

Christy Bieber, The Motley Fool

Can you still deduct interest paid on your mortgage after tax reform? Find out the answer here so you don't miss out on any deductions.

A toy house sitting on top of tax return forms.

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The mortgage interest deduction is one of the most popular tax deductions, claimed by an estimated 32.3 million people in 2017. However, homeowners who plan to claim this valuable deduction need to be aware of the new rules put into place by the Tax Cuts and Jobs Act.

The Tax Cuts and Jobs Act passed in December 2017 and many of its provisions are in effect for tax years 2018 to 2025. The Act changed the rules for both deducting interest on primary mortgages as well as for deducting interest on home equity loans and home equity lines of credit.

If you own a home or are thinking about buying one, you need to know what changes were put into place and how they'll impact you.

The mortgage interest deduction got a new limit

One of the biggest changes that was made is that a new cap was introduced on the amount of mortgage debt you can have before your interest is no longer fully deductible.

Under the old rules, you could deduct mortgage interest on loans valued at up to $1 million. However, under the new rules, you can only deduct interest on loans valued at a maximum of $750,000.  

This lower cap means that you will not be able to deduct the full amount of interest paid on your mortgage loan if you've purchased a home that requires a mortgage exceeding $750,000.

You can't take a deduction for mortgages on second homes anymore

Tax reform also changed the rules for mortgages on second homes. Under the old rules, if you purchased a second home, you could deduct the mortgage interest on it. You still were subject to the $1 million limit -- and that applied to total mortgage debt from both houses -- but as long as your two loans together didn't exceed $1 million, your interest would be tax deductible for the vacation property.

However, thanks to the changes made by the Tax Cuts and Jobs Act, mortgage interest is no longer deductible on a second home at all -- even if you are well under the new $750,000 limit on your primary home.  

This is likely to make it more difficult for many families to purchase vacation properties, since losing the deduction entirely will make the cost of the mortgage on their secondary home much more expensive.

Deductions on home equity loans and lines of credit are more limited

Tax reform also changed the rules for deducting interest paid on home equity loans and home equity lines of credit.  

Under the old tax rules, you were permitted to take a deduction on home equity debt no matter what purpose you borrowed the money for. Under the new rules, you're not permitted to take a deduction for interest costs on your home equity loan or home equity line of credit unless you have used the money from the loan to buy, build, or substantially improve the home that secures the mortgage debt.

So, if you take out a loan in order to remodel your home or to help you afford the costs of purchasing it, you can take a deduction for interest paid -- but you cannot do so if you have taken out a home equity loan or line of credit in order to pay off debt or accomplish any other financial goals you have that are not directly related to the improvement of your home.

Existing mortgages are grandfathered in

While it is bad news for homeowners that new limits on mortgage debt have been put into place, those who already own houses with higher mortgages are at least protected from loss.

That's because the new rules do not apply to mortgages that were issued prior to the enactment of tax reform. Mortgages before December 2018 when tax reform was passed are grandfathered in, so you don't have to worry about losing the ability to deduct interest that you've deducted without issue in the past.

It may no longer make sense to deduct mortgage interest anyway

While taxpayers may fear an increase in their federal income taxes as a result of the new restrictions on deducting mortgage interest, many taxpayers likely will no longer claim a mortgage interest deduction on their taxes anyway.

That's because you have to itemize in order to claim a deduction for mortgage interest -- and it's likely far fewer taxpayers will itemize in 2018 and beyond thanks to tax reform. Fewer taxpayers are likely to itemize because tax reform almost doubled the standard deduction.

Taxpayers must choose between claiming the standard deduction when they file taxes and itemizing their deductions to claim tax breaks for specific things such as paying mortgage interest. If the standard deduction is more than the total value of all itemized deductions added together, it doesn't make sense to itemize.

Prior to tax reform, the standard deduction was $6,350 for singles or married couples filing separately; $9,350 for heads of household; and $12,700 for married couples filing jointly. For tax years 2018 to 2025, the standard deduction has been increased to $12,000 for singles and married filing separately; $18,000 for heads of household; and $24,000 for married couples filing jointly.

You'll need to determine if your mortgage interest and other itemized deductions add up to at least those amounts. If they don't, then it no longer makes sense for you to itemize. You should claim the standard deduction instead, which means that you will not be able to deduct your mortgage interest.

Tax reform means major changes for homeowners

If you're a homeowner, or are thinking about buying a house, your tax situation will likely change in big ways because of tax reform. Not only are the rules for mortgage interest deductions different, but there have also been other big changes, including a new cap on the amount of your property tax and other state and local taxes you're able to deduct from your federal taxes.

It's important to know the new rules, both when you are deciding whether to purchase a home and when preparing to file your income taxes for tax year 2018 in April of 2019.

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