Under the recently passed tax legislation, many homeowners are left wondering how the long-standing federal tax benefits of homeownership will affect them. These changes are in effect as of January 1, 2018, so homeowners won’t see the impact until they file their 2018 taxes in the spring of 2019. But with tax season upon us, this new tax legislation is on many homeowners’ minds.
In sum, the new rules can be seen as less preferential toward homeowners. Changes to the tax law now reduce the amount of mortgage interest; state and local income, sales and property taxes; and interest from home equity lines of credit (HELOC) that you can deduct, if at all.
One of the biggest changes in the new tax law includes the home mortgage interest deduction (MID), which allows taxpayers to deduct from their annual income the interest that they paid during the year on a mortgage. This is applicable to a first or second home. But this new tax law means different standards moving forward.
Deductions, then & now
Previously, homeowners could deduct all local taxes paid in a given year and were able to deduct the interest paid on mortgage debt up to $1 million. Under the new law, however, that amount is reduced from $1 million to $750,000 for any home closed after December 15, 2017. Additionally, state and local income, sales and property taxes are now deductible up to only a combined $10,000. This change may not affect homeowners in less expensive markets with lower tax burdens, but it will likely make a difference to homeowners in more expensive, higher-taxed areas.
The deductions for homeowners are further reduced by the doubling of the standard deduction, which decreases the number of households that itemize their deductions. The new tax law increases the standard deduction to $12,000 for single filers and $24,000 for joint filers (formerly $6,350 and $12,700, respectively). For many homeowners, it no longer makes sense to itemize deductions.
Under the old tax law, roughly 44 percent of U.S. homes were worth enough for it to make sense for a homeowner to itemize their deductions and take advantage of the mortgage interest deduction. However, under the new legislation, only 14.4 percent of homes would be worth enough.
But now, more households will be more likely to maximize their tax breaks with a standard deduction rather than with individual itemized deductions, essentially removing the incentive to spend more on a home in hopes of recouping some of those costs later on.
HELOC interest deductions
In the past, homeowners could use their home equity to get low, tax-deductible interest rates on large purchases. For instance, homeowners could take out a HELOC to renovate their kitchen or pay off higher interest debt.
Previously, by taking out a HELOC, you could get a lower interest rate and deduct up to $100,000 in the interest you pay on that line of credit. But this cheaper financing may be a thing of the past under the new tax bill, as that loophole has been mostly closed.
Now, homeowners can deduct interest on HELOCs only under two circumstances: if the money is used to pay for home improvements or if the combined total of your first mortgage balance and HELOC don’t exceed $750,000 — the new limit on mortgage amounts qualified for interest deductions, which is down from the previous $1.1 million.
The good news is many people across the nation use HELOCs for the purpose of making home repairs. According to the Zillow Group Consumer Housing Trends Report 2017, 21 percent of homeowners take advantage of a HELOC. And of those who tapped into their home equity in the past two years, 55 percent did so to pay for improvements to their home.
Other equity options
If you were planning on taking out a HELOC to pay for something other than home improvements, or if the new tax rules make a HELOC less favorable to you, it might be worth looking into a cash-out refinance instead. Read more about the differences between HELOCs and cash-out refinance here. You can also talk to a mortgage professional to discuss your particular situation to see what’s best for you.
The bottom line
Homeowners and buyers should be aware of the implications of the new tax law as it applies to ownership. For some homeowners, the increased standard deduction may be beneficial. But for others, what might have made sense for you and your family before may no longer be applicable. If you have more questions about what the new tax code means for you, take a deeper dive into our research blog for answers.