Sweeping tax reform was signed into law by President Trump on December 22. The new tax law carries the official title “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.” Since that is a complete mouthful (and then some), this blog post refers to the law by its former and commonly used name: The “Tax Cuts and Job Act.” (“Act”).
I’ve had numerous calls on the question whether US persons living abroad having mortgage loans secured by their foreign residence can still deduct mortgage interest. Yes, mortgage interest is still deductible under the new rules, but more strictly curtailed. Here’s everything you need to know.
Under pre-Act law, a taxpayer could take an itemized deduction for so-called “qualified residence interest”. Generally, this is interest paid on a mortgage secured by what the tax law calls a “qualified residence”. A “qualified residence” is a principal residence (e.g., the taxpayer’s primary home) and one other residence owned and used by the taxpayer as a residence (think, vacation home). These rules remain the same under the new law, and it does not matter whether the residence is located in the United States or overseas.
“Acquisition Indebtedness” versus “Home Equity Indebtedness”
Under the old law, two types of interest were deductible – interest paid on so-called “acquisition indebtedness” of up to $1 million ($500,000 in the case of a married individual filing a separate return), plus interest paid on so-called “home equity indebtedness” of up to $100,000. Simply put, “acquisition indebtedness” encompasses any type of loan so long as the loan was used to purchase, build, or “substantially improve” any “qualified residence” of the taxpayer.
“Home equity indebtedness” is different and is any indebtedness that does not already count as acquisition indebtedness so long as it’s secured by a “qualified residence”. While the debt must still be secured by a “qualified residence”, taxpayers were given complete discretion as to how the funds from the loan were to be used. Taxpayers could use the borrowed funds to finance a new car or pay tuition, or to pay off credit card debts. It did not matter the purpose to which the funds were put, the interest was still deductible.
The rules change the deductibility of “qualified residence” interest, at least temporarily. For tax years beginning after December 31, 2017 and before January 1, 2026, the deduction for interest on “home equity indebtedness” is completely suspended (i.e., there will be no deduction permitted), and the deduction for mortgage interest on “acquisition indebtedness” is limited to underlying indebtedness of up to $750,000 ($375,000 for married taxpayers filing separately). Unless extended by Congress, these provisions of the new law will “sunset” (i.e., expire) on January 1, 2026 and the old law will be reinstated at that time.
As detailed below, the Act “grandfathers” certain mortgage loans for “acquisition indebtedness” providing them the benefits of the old law:
The new lower limit does not apply to any “acquisition indebtedness” that was incurred prior to December 15, 2017. There is no similar protection for “home equity indebtedness”, irrespective of when the loan was taken out.
“Binding contract” exception. A taxpayer who has entered into a binding written contract before December 15, 2017 to close on the purchase of a principal residence before January 1, 2018, and who purchases such residence before April 1, 2018, shall be considered to incur “acquisition indebtedness” prior to December 15, 2017. Under this provision, the taxpayer will be allowed the prior-law $1 million limit.
Refinancing. The old law’s $1 million/$500,000 limitations continue to apply to taxpayers who refinance existing qualified residence indebtedness that was incurred before December 15, 2017, so long as the indebtedness resulting from the refinancing doesn’t exceed the amount of the refinanced indebtedness.
The IRS will need to develop clear guidance for taxpayers; it will need to develop forms and systems capacity to distinguish between those mortgage loans subject to the $1,000,000 limit and loans subject to the $750,000 limit. Right now, there is a lot of confusion and taxpayers cannot expect the IRS to answer their questions any day soon. The National Taxpayer Advocate, Nina Olsen is worried that the IRS will have difficulty coping with the new tax legislation in light of its current budget (you can read the National Taxpayer Advocate Annual Report 2017 here).
You can read the text of the new law here.
UPDATE February 23 2018 The IRS recently issued some guidance on the new rules “Interest on Home Equity Loans Often Still Deductible Under New Law“.
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