Changes to Mortgage Interest Deduction Rules May Dampen Your Second Home Purchase
The tax “reform” enacted in Dec. 2017 will affect your ability to deduct mortgage interest going forward, in two ways:
1. Most of us will no longer be able to deduct home equity line of credit interest, a very popular form of borrowing for various household projects or short- to mid-term personal loan purposes. If you have a HELOC and have been taking the deduction as a homeowner, 2017 was the last time for doing so. This deduction is not grandfathered. (It used to be that you could deduct the interest paid on up to $100,000 in HELOC principal.)
Sometimes, folks use the HELOC as the means for a down payment to purchase a second home. If you do so, the interest you pay will not be tax deductible.
If the HELOC is used for a business purpose – to help finance your business or to purchase real estate to be held for use in trade or business, then the interest should still be deductible. But this is limited in its application. Most second homes do not qualify as investment real estate. If you have a second home that you rent out, you are limited to two weeks’ occupancy, yourself, in order to still call it an investment property. Expenses are fully deductible, including mortgage interest, for investment properties.
2. Unless you already have been using the mortgage interest deduction (MID) for loans up to $1m on your 1st and 2nd homes (in which case you are grandfathered), you will now be limited to deducting the mortgage interest on loans up to a principal balance of $750,000 for purchases in 2018 and beyond. For example, if you currently have a first mortgage of $500,000 and you are about to take a mortgage for $300,000 to buy a vacation home, the most you can deduct between the two mortgages is the interest on $750,000. You will have to decide which of the mortgages to deduct in full or prorate them. (In fact, let’s see what the regulations say on this point. You might have to prorate them; we’ll see.)