The recently passed Tax Cuts and Jobs Act (H.R. 1) has introduced a number of changes across the board. Given our real estate focus, we want to highlight the impact it has made on home mortgage interest and discuss how that may affect those of you planning to buy or sell a home in 2018.
Under the old tax law, a taxpayer could deduct interest on up to $1 million of acquisition debt for the purchase of the taxpayer’s first and second homes. Acquisition debt is money that is borrowed in order to purchase a company or asset – so the amount of mortgage you took out to buy your home. For example, if you buy a home for $800,000 and take out a loan for $650,000 at the time of purchase then your acquisition debt is $250,000.
Additionally, as a taxpayer you were able to deduct the interest on up to $100,000 of home equity debt. According to Greg McBride, Chief Financial Analyst for Bankrate.com, “A home equity loan is a fixed-rate installment loan where all the money is borrowed in one lump sum at inception and repaid in even monthly payments (or installments) over the term of the loan.”
Under the new law, the $1 million interest limit on acquisition debt has been lowered to $750,000 ($375,000 for married separate filers) for first and second homes. Note: Acquisition mortgages acquired before December 15, 2017 are grand-fathered into that $1 million cap.
Additionally, the new law does not permit any deductions for equity debt. This could negatively impact anyone who has used their home equity loan to pay for other costs (tuition, travel, etc). Again, these changes will take effect with 2018 tax returns.
While these are the primary changes that have been made to the taxation act there are a few carry-over rules we pulled from Murphy, Murphy, Murphy, Inc. that are worth noting as well:
Home Sale Exclusion – Generally, the tax code allows for the exclusion of up to $250,000 ($500,000 for married couples) of gain from the sale of a primary residence if you lived in it and owned it for at least 2 of the 5 years immediately preceding the sale. You also cannot have previously taken a home-sale exclusion within the 2 years immediately preceding the sale. There is no limit on the number of times you can use the exclusion as long as you meet these time requirements. However, extenuating circumstances can reduce the amount of the exclusion. The home-sale exclusion only applies to a primary residence, not to a second home or a rental property.
2 out of 5 Rule – To qualify for the home-sale gain exclusion, you must have used and owned the home for 2 out the 5 years immediately preceding the sale. If you are married, both you and your spouse must meet the use requirement, but only one of you needs to meet the ownership requirement. Vacations, short absences and short rental periods do not reduce the use period. When only one spouse in a married couple qualifies, the maximum exclusion is limited to $250,000 instead of $500,000. Although this situation is quite rare, if you acquired the home as part of a tax-deferred exchange (sometimes referred to as a 1031 exchange), then you must have owned the home for a minimum of 5 years before the home-gain exclusion can apply.
With tax season encroaching upon us, it is essential to peruse these rules and have a realistic explanation of what to expect. Feel free to reach out the Weber Accetta Group for assistance – we are happy our advice and also direct you to our trusted financial consultants.