August 2, 2018
HOME EQUITY LOANS AND LINES OF CREDIT have long been a popular way for homeowners to pay for big-ticket items, ranging from college to cars to new kitchens. A large part of their appeal had always been the tax deduction you could claim on the interest charged.
The Tax Cuts and Jobs Act of 2017 changed all that, limiting the scope of eligible deductions—and creating some confusion along the way, with some homeowners initially thinking that the new law eliminated the tax deduction altogether.
The interest deduction is allowed when you make home improvements that increase the value of your home, prolong your home’s useful life, or adapt your home to a new use.—Vinay Navani, CPA, a shareholder at Wilkin & Guttenplan
Fortunately, the IRS recently clarified the rule: Previously, you could deduct all the interest you paid on home equity loans and lines of credit, generally up to $100,000, but you can now deduct the interest only if the money is used to buy, build, or substantially improve your home that secures the loan, and only the interest on up to $750,000 in combined mortgage and home equity loans.1 We asked Vinay Navani, CPA, a shareholder at Wilkin & Guttenplan, for insights on what the new rule might mean for homeowners considering tapping their home equity for major expenses.2
What’s a “home improvement,” and what isn’t?
The interest deduction is allowed when you make home improvements that increase the value of your home, prolong your home’s useful life, or adapt your home to a new use. “You’re typically looking at bigger-ticket items: new carpeting, new flooring or finishing a basement,” Navani explains. Although smaller improvements, including partial bathroom or kitchen renovations, may also make the cut when it comes to deductions, it’s important to be careful of gray areas such as furniture or appliance purchases. “While a dishwasher can improve your quality of life, it typically won’t improve the value of your home and is unlikely to count as an allowable deduction,” Navani says.
Does it still make sense to borrow against
your home equity?
Of course, you can still borrow against your home equity for all sorts of uses—including college expenses. Just don’t count on being able to deduct the interest unless the expense falls under the new guidelines. “The key to dealing with the new rule on interest deductibility is to focus on all of the changes in the tax code,” says Navani. For some homeowners, the loss of home equity tax deductions for certain uses may be offset by the larger standard deduction and a lower income tax rate under the new law. So it may not be necessary to change up your liquidity strategy dramatically. Be sure to talk to your tax advisor about how the new law affects your overall allowable deductions.
“Depending on your personal circumstances, you may also want to look into other options such as credit cards, personal savings or a Loan Management Account® (LMA®) to cover expenses that no longer qualify for an interest deduction under the new tax laws,” says Marie Imundo, senior vice president of Mortgage Product Strategy for Bank of America Merrill Lynch's Global Wealth & Investment Management division.
While recent tax law changes do signal a shift in the way many homeowners think about—and use—their equity, keeping your larger goals in mind can help you make a decision that’s right for you.
You can find more information on home financing and home equity lines of credit here. For more insights on how the Tax Cuts and Jobs Act could affect your financial decisions, read Tax Reform and Your Life: What’s Changed?
1Internal Revenue Service, IR-2018-32: Interest on Home Equity Loans Often Still Deductible Under New Law
2Vinay Navani, CPA, is not affiliated with Merrill Lynch. Opinions provided are his, do not necessarily reflect those of Merrill Lynch and may be subject to change. Neither Merrill Lynch nor its advisors provide legal, tax or accounting advice. Please consult your tax advisor about the insights provided here.
Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
The Loan Management Account (LMA account) is a demand line of credit provided by Bank of America, N.A., Member FDIC. Equal Opportunity Lender. The LMA account requires a brokerage account at Merrill Lynch, Pierce, Fenner & Smith Incorporated and sufficient eligible collateral to support a minimum credit facility size of $100,000. All securities are subject to credit approval and Bank of America, N.A. may change its collateral maintenance requirements at any time. Securities-based financing involves special risks and is not for everyone. When considering a securities-based loan, consideration should be given to individual requirements, portfolio composition and risk tolerance, as well as capital gains, portfolio performance expectations and investment time horizon. The securities or other assets in any collateral account may be sold to meet a collateral call without notice to the client, the client is not entitled to an extension of time on the collateral call and the client is not entitled to choose which securities or other assets will be sold. The client can lose more funds than deposited in such collateral account. The LMA account is uncommitted and Bank of America, N.A. may demand full repayment at any time. A complete description of the loan terms can be found within the LMA account agreement. Clients should consult their own independent tax and legal advisors. Some restrictions may apply to purpose loans and not all managed accounts are eligible as collateral. All applications for LMA accounts are subject to approval by Bank of America, N.A.
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