Maximizing the tax benefits of mortgage interest, home equity loans

Understanding options with residential deductions is a great way to add value for clients

Oct 28, 2017 @ 12:06 am

By Tim Steffen

The tax reform framework recently released by President Donald J. Trump proposes eliminating most itemized deductions, except for those regarding mortgage interest and charitable contributions. It also nearly doubles the standard deduction, meaning only those individuals who have large mortgages and/or are very charitable will likely continue to itemize their deductions.

Conversely, the latest IRS statistics estimate that 32.7 million tax returns were filed in 2015 claiming the deduction for mortgage interest. That would certainly decrease under the proposed change, but those who remain are likely your biggest clients. And while tax reform is a priority for the president, there's no certainty what the final bill will include or when it will be effective.

So don't discount this seemingly basic yet complicated deduction. Although it's a long-standing part of our tax code, recent changes create planning opportunities.

The Basics: The first test when deducting mortgage interest — and the rule that's most likely to trip up financial advisers — is determining how the loan is secured. It's not unusual for clients who want to avoid securing a traditional mortgage, especially when they are building a new home, to consider a short-term loan secured by their investment portfolio.

Qualifications

However, IRS Publication 936, Home Mortgage Interest Deduction, states that to be deductible as mortgage interest, the loan must be secured by the home. With any other form of security, the interest isn't considered qualified mortgage interest and is therefore nondeductible. That interest also isn't deductible as investment interest, since the loan proceeds weren't used to purchase investments. Bottom line: Clients shouldn't use their investment portfolio to secure a home loan.

Assuming the loan qualifies for a deduction, then your client should consider the size of the loan. Only interest on the first $1 million of "home acquisition debt" is considered deductible. The interest on any debt beyond that level is not deductible. And even though they can deduct the interest on loans for a primary residence and a second home, the $1 million exclusion is a combined amount across both homes.

One twist on this rule — last year the IRS decided that two unmarried individuals who co-own the same home can each deduct the interest on $1 million of debt. Married couples only get a single $1 million amount. Divorce isn't a popular tax planning technique, but it could be a way to maximize the mortgage interest deduction.

Home Equity Loans: A deduction is also available for interest paid on up to $100,000 of debt not considered acquisition debt. This is ideal for those clients who maintain a home equity line of credit, or use their equity to finance a car or other purchase. One caveat: If the equity loan proceeds aren't used to buy, build or improve the home, the interest is not deductible for alternative minimum tax purposes.

Multiple Homes

On the other hand, in 2012 the IRS ruled that the $100,000 doesn't have to be a true home equity loan. If the acquisition loan exceeds $1 million, the next $100,000 of that debt can be treated as home equity debt. In other words, the $1 million limit is really $1.1 million.

Multiple Homes: Interest is deductible on loans used to acquire a primary residence and a second home, and the rules are flexible about what qualifies as the second home. This can include a home, condo, mobile home and even a boat — as long as it has sleeping, cooking and bathroom facilities.

For those clients with multiple homes, only one home can be the second home each year, but there's also flexibility in changing that when homes are bought or sold during the year. Plus, it's possible to change which home is the second home from year to year.

Although it's uncertain how our tax system will look in the near future, understanding options with the mortgage interest deduction is a great way to add value for clients.

0
Comments

What do you think?

View comments

Recommended for you

Sponsored financial news

Upcoming Event

Mar 13

Conference

WOMEN to WATCH

arjuna-design is honoring female financial advisers and industry executives who are distinguished leaders at their firms. These women have advanced the business of providing advice through their passion, creativity, inclusive approach and... Learn more

Reporter Ryan Neal discusses how investors inside and outside financial advice have become interested in the industry's technology, and introduces us to some top people fueling the trend.

Recommended Video

Channels

Latest news & opinion

These funds have gained more than 10% in just a month

And not all of the funds did it with tech stocks

As Finra elder-abuse rule takes effect, advisers will face awkward conversations

Regulation taking effect Monday requires reasonable effort to find trusted contact, allows brokers to stop fund disbursement.

As Trump prepares for State of the Union, 50% of advisers approve of his job performance

Percentage is 10.3 points higher than the general population approval rating.

Morgan Stanley said to be trimming 600 funds from platform

While not confirming the number of funds on the chopping block, the firm acknowledged it is culling its offerings.

Independent broker-dealers are stepping up their game on recruiting from the wirehouses

Independent broker-dealers have narrowed the gap between themselves and the wirehouses and are able to attract more quality brokers from the Big Four.

X

Hi! Glad you're here and we hope you like all the great work we do here at arjuna-design. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting arjuna-design.com? It'll help us continue to serve you.

Yes, show me how to whitelist arjuna-design.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Last News

charles schwab equity award center life insurance ira savings plus program calpers cfp message board pimco high yield admin certified financial planner salary taxes on reits medicare adjusted gross income vanguard retirement calculator vanguard s&p 500 index fund admiral irs ira transfer rules dividend income taxation max 401k contribution for married couple national committee to preserve social security and medicare scam how is social security benefit calculated what is the best definition of unearned income average income for seniors on social security vanguard 500 index fund admiral class is stratton oakmont still in business are taxes deducted from social security checks kinder morgan energy partners stock price can a traditional ira be converted to a roth ira short duration high yield bond funds is social security taxable after age 66 how much does jcpenney pay per hour unclaimed stocks and bonds million dollar penny 1943 vanguard index fund expense ratio is social security retirement income taxable form ssa 1099 social security t rowe price personal strategy income cullen high dividend equity are stock dividends taxed 1943 magnetic wheat penny bny mellon investor services columbia management future scholar 529 lord abbett short duration income c vanguard institutional index plus