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IRS clarifies new tax law's effect on home-equity interest deductions

The high cost of housing in Southern California makes the deductibility (or not) of interest on a mortgage or a home equity loan an important issue.

The recently enacted federal tax overhaul significantly downsized the size of the mortgage interest deduction for newly-purchased homes. The size of the deduction has been cut from the first $1 million of mortgage interest (plus $100,000 in equity debt) to the first $750,000.

But has the deductibility of the interest paid by homeowners on home equity loans or lines of credit also changed?

On February 22, the Internal Revenue Service provided guidance on deductions for payments of home-equity loan interest.

The IRS said that homeowners may still be able to take deductions for interest paid on:

• a home equity loan;
• a home equity line of credit (HELOC); or
• a second mortgage (sometimes called a "re-fi")

What was the purpose for your loan or re-fi?

There is, however, an important qualification that must be met for deductions of home-equity interest payments to be valid. They must be for transactions to "buy, build or substantially improve the taxpayer's home that secures the loan."

This means that if you use home-equity or re-fi funds for a home improvement project such as remodeling your kitchen, the interest deduction is in order, as long it meets other relevant criteria.

But if you use the funds to take a cruise, or even to help a kid pay for college, that is another matter.

Similarly, if you use a loan on your primary residence to buy a vacation home, the interest on the loan could not be deducted because it is not being used to acquire or improve the primary residence.


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