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You are a homeowner, and you pay taxes. But if you find yourself absentmindedly nodding along when someone mentions terms like the standard deduction, itemizing and mortgage interest deduction, you’re probably more confused than ever about how the new tax bill (a.k.a. Tax Cuts and Jobs Act) will impact you as a homeowner. If so, we’re here to help.
Before we get started, it’s important to note that each individual’s tax situation is different. Consult a qualified tax professional before making any tax moves. Take note that the new laws likely won’t affect your 2017 return, which most people are filing before April this year. Also, while many of the provisions in the new legislation are permanent, many will expire after 2025. If you’re looking for a general review of the new tax bill and how it may impact other aspects of your finances, check out our overview on the new tax bill article.
Do you itemize?
When you do your taxes, you likely either take the standard deduction or itemize. Itemizing means that you list “item by item” things you may deduct from your income to determine the amount you’ll pay taxes on. The standard deduction simplifies taxes somewhat by assigning a “standard” amount to deduct from your income, regardless of deductions like charitable giving, student loan interest paid or mortgage loan interest. Previously, choosing to itemize only made sense if all of your “qualifying” deductions yielded more tax savings than taking the standard deduction.
Why does this matter?
The new tax bill nearly doubles the standard deduction, from $6,350 to $12,000 for individuals, and from $12,700 to $24,000 for married people filing jointly. Previously about 28% of taxpayers itemized, according to a study by Urban Brookings Tax Policy Center, but with the tax law change, it is likely that more people will opt for the simplified standard deduction.
So what about the housing deduction?
Under the old tax rules, taxpayers often chose to itemize because they could deduct their mortgage interest. Now, with a higher ceiling due to the increased standard deduction, fewer people may “use” the mortgage deduction.
If homeowners continue to itemize, there are two notable changes:
- Deductible mortgage interest for new purchases is capped at $750,000 on a qualified residence, down from $1 million. To deduct, the debt must be used to acquire, build or substantially improve a primary residence. Existing mortgages as of Dec. 15, 2017, are “grandfathered” in at the $1 million limit.
- Debt for anything other than acquiring a residence (such as using a home equity loan to consolidate credit card debt) is no longer deductible in 2018, where last year it was deductible up to $100,000.
For example, let’s say the Smith family owes $100,000 on a home worth $200,000. They decide to refinance to a new 30-year, fixed mortgage, and they borrow $120,000 on a “cash-out” refinance, using $20,000 to buy a new car. Interest on $100,000 of the loan may be deductible, but the interest on the $20,000 is not.
An important distinction is that this “acquisition indebtedness,” which is still deductible in 2018, is not based on the type of loan but on how the funds were actually used. Tax forms from your lender don’t reflect how the funds are actually used, so it’s the taxpayer’s responsibility to keep track if they are trying to deduct it from their taxes.
Here’s another example: The Jones family takes out a home equity line of credit on their existing home to build a new bedroom addition. Since this is a “substantial improvement” to their home, the interest may be deductible. If they used the funds to pay off credit card debt, it would not be deductible.
All this adds up discussing your specific tax situation with a qualified tax professional, particularly if you are looking to use a home equity loan or refinance for uses other than buying, building or substantially upgrading your property.
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The contents of this document are not intended to be, and are not, legal or tax advice. The applicable tax law is complex, the penalties for non-compliance are severe, and the applicable tax law of your state may differ from federal tax law. Therefore, you should consult your tax and legal advisors regarding your specific situation.