The newly enacted Tax Cuts and Jobs Act of 2017 (TCJA) both simplified and complicated many of the tax rules beginning with the 2018 tax filing season. One of these changes, new rules with regard to taxpayers’ mortgage interest deduction, on the surface seems simple but in reality is quite the opposite.
The new rule with regard to home residence mortgages allows a deduction for interest on a taxpayer’s mortgage and equity debt, where the combined debt is capped at $750,000 ($375,000 if married filing separate status). This cap is for residences purchased after December 15, 2017. However, for taxpayers that have an existing mortgage on their residence obtained prior to December 16, 2017, the debt limit remains $1,000,000 ($500,000 if MFS). This older mortgage debt is considered “Grandfathered Debt” and is not impacted by the new $750,000 cap. Additionally, just to confuse taxpayers a bit more, the TCJA made an exception to the new rule where a taxpayer who enters into a written binding 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, will be considered to have incurred the home acquisition debt prior to December 16, 2017; thus, making the cap on this debt $1,000,000.
Prior to 2018, interest on up to $100,000 of home equity debt was allowed as a tax deduction and taxpayers were not restricted in their use of the home equity loan. Personal use of home equity debt was allowed to qualify for a mortgage interest deduction. The TCJA only allows a deduction for home equity interest if the proceeds of a home equity loan are used for renovating or improving the home. If the proceeds of the debt are used for personal items, the interest paid on the debt will no longer be deductible. For mortgages taken out after 2017, the combined total of mortgage debt plus additional home equity debt (used to improve or renovate a house) is capped at the new $750,000 threshold.
Are you thinking of purchasing a second home? Assuming your total debt combined on both homes will be under the new $750,000 cap, be sure the new mortgage will be secured by the new home. If you take out an equity loan on your primary residence which is then used to purchase the second home, the interest on the home equity loan will not qualify to be deductible mortgage interest even if the combined loans on the primary residence are less than $750,000. Only interest on mortgage and home equity debt used to purchase, improve, renovate or construct the home being mortgaged will qualify for the mortgage deduction. Taking a loan out that is collateralized by one home in order to purchase a second home will not qualify as deductible mortgage debt.
Refinancing also poses numerous complexities depending on the amount of debt to be refinanced and when the original loan was taken out. Refinancing a mortgage is considered acquisition debt to the extent that the new debt does not exceed the outstanding principal on the old debt immediately before refinancing. Taxpayers that refinance grandfathered debt, are allowed to deduct mortgage interest on the new debt in full, up to the amount of grandfathered debt outstanding just prior to the refinance. For example, if your current mortgage outstanding is $950,000 and this mortgage was in place prior to December 16, 2017, after refinancing you can deduct mortgage interest on the refinanced debt of $950,000. Your refinanced debt will not be capped to the new $750,000 threshold, even if the refinance occurs in 2018.
If a taxpayer does a cash out refinance (even if the cash out is solely for closing costs), the amount of new debt in excess of the old debt outstanding just prior to refinancing will not qualify as mortgage debt even if the total new debt is less than the $750,000 threshold. For example, if a taxpayer refinances their existing debt in the amount of $400,000 with a new debt in the amount of $450,000 and does not use the additional $50,000 cash out for a home renovation or improvement, then only interest paid on $400,000 will qualify for the mortgage interest deduction..
With the new rules for mortgage debt and home equity debt fully in place as of December 15, 2017, taxpayers will need to pay close attention to the tax ramifications of refinancing existing home mortgages and of using home equity loans, prior to making their financial decisions.
Question about refinanced grandfathered debt and deductibility. Suppose I refinance a 2016 mortgage, present principal $850K. I refinance at a new 30 year fixed and I also finance $5K of closing costs (which is technically cash out). I believe that the refinanced loan’s interest on the $850K is not tainted by the additional $5K financed — I just can’t deduct the interest on the $5K. But it’s tough to find authoritative guidance from the IRS on this.
Aside: I have read that the extended term created by going out to 30 years again creates its own issues issues, but there’s even less written on this matter.
You are correct. In your scenario I assume your new debt would be $855K ($850K of debt refinanced plus $5K of closing costs added into the new debt). Although the refinanced debt is in excess of the new $750K limitation, your allowed mortgage deduction debt would be grandfathered in at the amount of the old debt just prior to refinancing – because the original debt is less than $1M and the debt was in existence prior to December 16, 2017. The refinancing costs added into the new debt would not qualify as mortgage debt for the allowed interest tax deduction because this $5K ?cash-out? was not for capital improvements and the refinanced debt is in excess of $750K. Thus, only interest in the percentage of 99.4% (850K/855K) would qualify as tax deductible.
The mortgage interest deduction is not impacted by the term of the loan.
What if I refinanced a March 2017 mortgage in March 2020. I understand that I am grandfathered back to the original mortgage. If I refinance again in December or January 2021, can I still grandfather back to my original March 2017 mortgage or am I stuck with the $750,000 limit.
I purchased a house in October 2017 with a 1st mortgage of $715K and a 2nd mortgage of $85K and $85K down payment, then refinanced in 2019 into a single mortgage of $765K.
Does the total of my original loans $800K ($715K + $85K) set my mortgage interest deduction cap at $800K since it was completed before December 2017?
Or is my cap now $750K because my new loan of $765K is larger than my initial 1st mortgage of $715K? Essentially, the 2nd mortgage is not considered part of my total mortgage cost in 2017? 2nd mortgage was not a HELOC.
Hi Rich, If your mortgage was in place prior to December 16, 2017, you would be capped under the old threshold of $1,000,000 of mortgage debt. Having purchased your home in 2017 and with the original debt being in October 2017, you fall under the pre-2018 rule change. But any increased debt at the time of refinancing would not qualify for the mortgage deduction cap unless funds were drawn out for home improvements. Assuming no improvements in your scenario, If you refinance after 2017, then your new mortgage interest deduction cap would be the combined amount of debt outstanding on your 2 loans at the time of refi.
Hi! If I took out a 30-year $1.2M loan in 8/2017 and am refinancing the remaining $1.03M in 3/2021, does the new loan need to end in 8/2047 (i.e., 26.5 year new loan term) for me to be able to write off the entire $1M amount? Or am I good to sign a new 30-year loan? I’m referring to the language below:
“For home acquisition debt to continue to be grandfathered under the old rules of $1 million, the refinanced debt can only be for the amount of the old mortgage debt and for the remaining original debt term. There can be no cash taken out – even to cover closing costs. If the refinanced term is extended, the grandfathered portion ($1 million) only applies for the remaining years of the original loan term.”
Hi Ross, Yes, you should still be able to deduct up to the $1 million of grandfathered debt if you were to sign a new 30-year loan for the term that is left on the original loan, which would be for the next 26 or 27 years. Extending the mortgage terms beyond the life of the original loan by 3.5 years will only affect you during those last few years if you were to carry the loan for its entire life, which is quite rare. For those last few years, it would only be deductible home acquisition debt to the extent that it was used to buy, build, or substantially improve the home.
The value of the pre-12/15/17 $1,000,000 limit seems to be reduced if the mortgage is refinanced after that time. Example: mortgage with a $1.5M balance is refinanced in 2020 for the same amount. No money is taken out. But Publication 936, Table 1, Part 2, Line 12 requires “Enter the total of the average balances of all mortgages from lines 1, 2, and 7 on all qualified homes.” Adding the average balances of the old and new mortgages together puts $3M on that line, cutting in half the percentage on line 14 that would have applied but for the refinancing. So the amount of deductible interest on line 15 is likewise cut in half.
I understand that the $750K cap applies to the refinanced mortgage, but the above calculations on the worksheet seem to cut into the $1M cap that should still apply to the original mortgage. This doesn’t make sense to me. Help, please.
look at the definition of ‘average’… it’s the old mortgage’s interest for 2020 / its interest rate PLUS the new mortgage interest for 2021 / its interest rate. A simple two point average will not work
I have a mortgage from before Dec 2017 for 680,000 (primary home) and a mortgage acquired after 2017 for 500,000 (second home, not a rental). So mortgage interest from the first mortgage is fully deductible, but what about the second mortgage, how much of it is deductible ?
Hi Pierre, You can deduct home mortgage interest on the first $750,000 ($375,000 if married filing separately) of indebtedness when factoring in mortgage interest on a second home purchased after December 16, 2017. To figure the actual deductible interest, you have to use one of the IRS’s required average balance methods. Overall, you should be able to deduct a bit more interest by taking on the second loan in this situation.
I did a cash out refinance of my mortgage (that I took out in 2015 to purchase my house) and the outstanding balance was 980K at the time of refi. The new balance is 1180K and all the cash will be used for capital improvement. What’s the mortgage balance that’s applicable for mortgage interest deduction? Is that 980K or 1180K or 750K?
I have 1098’s for the old and new loans. Is the interest on the first loan 100% deductible and I apply the limitation to the new loan only?
I have a 30 year mortgage from 2013 that is currently at 785,000. We took out a HELOC in 2019 for 100,000 and have not needed to pay on it so it is currently still at 100,000. We are looking to refi into a fixed mortgage and roll the HELOC into the current mortgage to make a mortgage of 885,000. How will our ability to deduct interest change after the refinance?
If you’ve purchased the home prior to December 15, 2017 then the TCJA changes to limit mortgage interest deduction do not apply. You are able to deduct interest on the acquisition indebtedness (the mortgage to purchase, construct or substantially improve the home) up to $1 million. If married filing separate then reduced to $500k. As long as the HELOC was used to improve the home then it can be refinanced and you can deduct the interest for principle under 1 million.
I don’t believe this permutation was directly addressed in the comments and I am got conflicting advice on this and was hoping you could clarify it for me. My situation is as follows:
My original mortgage, from February 2017, has a balance of ~$1,050,000. I intend on now refinancing with a loan in the amount of about ~$1,250,000, with the excess $200K being used for closing costs and to pay for items other than home improvements.
Will I get dinged because I’m taking cash out and now be subject to the $750K cap, or will I be currently entitled to the full $1 million because my current principal is in excess of $1 million.
If I am now entitled to the full $1 million, let’s say over the next year I pay off $75,000 in principal on the new loan, will I then be capped at $975K (i.e., principal of grand-fathered loan minus principal paid down on new loan) or do I stay subject to the $1 million cap so long as the new loan principal balance remains at $1 Million or above?
Greatly appreciate your thoughts. Thanks
Any idea if home improvements (new windows) done prior to the cash out refinancing would count towards the “must be spend on improvements?” Perhaps since that made my property’s basis higher for tax purposes? Or only improvements subsequent to refi count?
I have an outstanding mortgage of $350K on my townhome purchase in 2019. It acquired about $10K of interest in 2021. Then on Nov 2021, i purchase a new home with a mortgage of $740K in which i paid about $2K of interest during closing. Then the townhome is sold in Dec 2021. So only for a brief period of time that my total mortgage debt above the $750K limit. But i am getting penalized for the entire year of mortgage interest can only deduct a reduced amount of $8K. Am I understanding the tax code correctly? or can i just not claim the new mortgage interest all together i would get to deduce the entire $10K from my old mortgage?
Much appreciate to hearing your advice.
Hi Jason, that’s a good question and shows how tax code isn’t always straightforward. We’d suggest you reach out directly to a CPA. They should review your loans and actual interest payments and then can advise you on the correct interest deduction.
I originally had a 1998 mortgage on my house that i had built. Over the years, that mortgage was refinanced to take advantage of falling interest rates. The last regular mortgage was in 2013. Each time, the mortgage was for less than the original mortgage balance.
In Nov 2015, I refinanced the 2013 mortgage with a Reverse Mortgage for only the remaining balance on the 2013 mortgage. In June 2021, I sold the house and purchased a new residence from the sales proceeds.
Is the amount of the reverse mortgage considered all acquisition debt? It is not clear to me how the IRS interprets refinancing with reverse mortgages when there are no cash proceeds other than to pay off the loan being refinanced. I was under the assumption that grandfathered debt must originate 1987 or earlier????
I appreciate your response.
Hi Mark, The best advice we can give you right now is to reach out and work directly with a CPA. They’ll need to look into your specifics loans and reverse mortgage.
I have a $1.4 million loan for a home purchased prior to the 2017 tax change. If I refinance that loan and take cash out that is not used for home improvement, am I still able to use the $1,000,000 limit for married filing jointly, or am I now limited to the $750,000 cap, just because I increased the amount of the loan for reasons other than home improvement, despite the fact the original amount exceeded $1,000,000?
Thanks so much.
Does the $1 cap apply to a construction home loan? I took out a construction loan for $1.4mil in Jan 2017 to build my custom home. My house took a year to build and was converted to a traditional mortgage loan in August 2018. Would I still qualify for the $1 cap since the debt occurred prior to Dec 16, 2017 and the house is my primary residence?
I bought my home for $850K in Jun 2016. VA loan. Refinanced twice during covid,
1st mortgage $815,657.07 Jun 2016 3.25%
Refinanced $749,785 to $759,950 Jun 2020 2.75%
Refinanced $750,358 to $757,387 Apr 2021 2.25%
Now I’m thinking of doing a HELOC to substantially renovate the home.
Can I take out a HELOC for $200,000 now and be grandfathered to the $1,000,000 interest deduction CAP so I can deduct both the home and HELOC interest.
Hi Mike, Unfortunately no. The $1 million cap only applies to mortgages taken out prior to the December 16, 2017 date. Any new debt taken out after December 15, 2017 would not be grandfathered into the $1M threshold, the cap would be $750K. Thus, in the scenario you mention, the interest paid on the HELOC taken out after December 15, 2017 would not be deductible because your total debt already exceeds the $750K cap.
I bought our home in December 2015 using a loan for $999,999, 30-year fixed at 3.65%. I refinanced in December 2020 for $895,000 at 2.79%–this is a new 30-year fixed loan, which extended the end date from 2045 to 2050. No money was taken out. I only refinanced the remaining principal and paid all closing cost fees out of pocket.
1) Does my refinanced loan (a new 30-year fixed) qualify for 100% deduction post TCJA?
2) And if it does qualify, do I enter in the refinanced amount ($895,000) or 0 in line 7 of IRS Pub 936 (Worksheet Table 1)?
Hi Shon, for your first question – If you did not increase the amount of your principal outstanding at the time of refi, you will qualify to claim a mortgage interest deduction on the entire refinanced debt noted as $895,000. Because the original debt was taken out prior to December 16, 2017, the refinanced debt will still fall within the $1M “grandfathered” debt limit of the TCJA and will not be limited to the post December 15, 2017 $750K debt limit.
And for the second – You would report your average outstanding debt on line 2 of the worksheet (original debt plus refinanced debt after December 15, 2017 that qualifies as original debt). Line 7 would be $0 in your scenario.