Dividing Debt Preserving Credit in Divorce

Dividing Debt Preserving Credit in Divorce

Home Equity Interest May Be Deductible in 2018

Home Equity Interest May Be Deductible in 2018

Home equity interest may still be deductible in many cases, according to the IRS, even though the tax deduction for home equity interest was eliminated by the Tax Cuts and Jobs Act of 2017 (TCJA).  Still, an explanation recently issued in an IRS publication might not satisfy divorcing spouses who want to borrow against their homes to clear up marital debts or pay a divorce settlement.

For the years 2018 through 2025, interest on home equity loans (HELOC) will not be tax deductible under IRC 163(h)(3)(F)(i)(I), as amended by TCJA. Previously, the mortgage interest deduction was limited to the interest on acquisition indebtedness not exceeding $1,000,000, plus home equity indebtedness not exceeding $100,000 (or half of those limits for MFS taxpayers).  The law has always distinguished between acquisition indebtedness and home equity indebtedness.

TCJA contains a grandfather clause to preserve the deduction for pre-existing mortgage loans (but not home equity loans), and a tracing clause to preserve the deduction for mortgage loans that are refinanced.  For mortgage loans that existed prior to December 15, 2017 (or were approved by 12/15/17 and closed before 4/1/18), the interest on up to $1,000,000 acquisition indebtedness is still deductible under TCJA.  If an existing mortgage loan is refinanced, then the taxpayer may deduct the interest on the portion of the new loan that does not exceed the outstanding balance of the old loan.  The interest on the excess portion, however, is not deductible.

The label home equity loan does not automatically prevent borrowers from deducting the interest, however.  Regardless of the label, a borrower may deduct the interest if it qualifies as acquisition indebtedness, which includes any loan that is incurred in acquiring, constructing or substantially improving a qualified residence of the taxpayer and which is secured by the residence. A qualified residence means the taxpayers principal residence and one other residence of the taxpayer.

In IRS publication IR-2018-32, issued on February 21, 2018, the agency announced:

The Internal Revenue Service today advised taxpayers that in many cases they can continue to deduct interest paid on home equity loans.

Responding to many questions received from taxpayers and tax professionals, the IRS said that despite newly-enacted restrictions on home mortgages, taxpayers can often still deduct interest on a home equity loan, home equity line of credit (HELOC) or second mortgage, regardless of how the loan is labelled. The Tax Cuts and Jobs Act of 2017, enacted Dec. 22, suspends from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build or substantially improve the taxpayers home that secures the loan.

Under the new law, for example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not. As under prior law, the loan must be secured by the taxpayers main home or second home (known as a qualified residence), not exceed the cost of the home and meet other requirements.

For taxpayers who are divorcing, the home equity interest deduction was a benefit in the past, because it allowed spouses to borrow money to pay off a divorce settlement and deduct the interest.  In the future, that tax strategy will not work, because borrowing to pay consumer debt or a divorce settlement is not acquisition indebtedness.

For more information about home equity interest and other tax deductions affecting separated and divorced spouses, read my book Frumkes & Vertz on Divorce Taxation (James Pub.2017).  For legal help with complex divorce financial issues in Western Pennsylvania, call me or use the contact form.

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