Beginning with 2018 returns, the new Tax Cuts and Jobs Act (TCJA) eliminates certain tax deductions, such as the write-offs for miscellaneous and job-related moving expenses, and cuts back on others. The changes remain in effect through 2025. But you may still claim top-dollar deductions for interest expenses on Schedule A, albeit with some modifications, if you itemize this year.
Typically, the deduction includes mortgage interest or investment interest expenses or both:
1. Mortgage interest: In the past, you could deduct mortgage interest expenses that qualified as either “acquisition debt” or “home equity debt”:
- Acquisition debt occurs when mortgage proceeds are used to buy, build or substantially renovate a home. Frequently, interest on acquisition debt represents the main part of an interest expense deduction. To qualify for a deduction, the loan must be secured by a qualified residence, such as your principal residence or a second home, like a vacation home. Prior to the TCJA, acquisition debt interest was deductible on loans up to $1 million. Now, the threshold for acquisition debt deductions has been lowered to $750,000 for loans originating after December 15, 2017 (April 1, 2018 if there was a binding contract in place before December 16, 2017). Thus, many homeowners with existing mortgages are “grandfathered” for payments on acquisition debt. And there still may be plenty of room to deduct interest under the new rules.
- Then there’s home equity debt. When permitted by state law, you could also deduct the interest on home equity loans secured by a qualified residence, regardless of how the proceeds were used. With this type, deductions were limited to interest paid on the first $100,000 of debt. Additionally, the loan amount could not exceed your equity in the home.
However, the TCJA suspends the deduction for home equity debt after 2017 and through 2025, so it isn’t available on 2018 returns. Key point: A home equity loan may be treated as an acquisition debt if the proceeds are used to substantially renovate a home (see above). Accordingly, you still may be able to deduct interest on home equity loans used for house improvements.
As before, taxpayers may deduct “points” as mortgage interest if the loan is secured by a qualified residence and certain other requirements are met. Points on a refinanced loan must be amortized over the term.
2. Investment interest: If you incur investment interest expenses—for example, when you buy stock on margin—you can the deduct the interest up to the amount of your net investment income for the year. Any excess is carried over to the next year.
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For this purpose, “net investment income” equals your investment income minus investment expenses (other than interest). Therefore, you can add up items such as interest, dividends, royalties, gains from sales of investment real estate and so on. Caveat: You cannot count long-term capital gains and qualified dividends as investment income. Because these items already receive favorable tax treatment under the law, they are excluded from this computation.
Fortunately, however, there is another option. When you file your 2018 tax return, you can elect to include certain long-term gains or qualified dividends or both in the calculation of net investment income if you reduce the amount eligible for the favorable maximum tax rate by the same amount. In other words, you can cherry-pick the capital gains or dividends for this special tax return election. It’s not an all-or-nothing proposition.
Practical advice: Inform and educate your clients about these aspects. Then, you can help them maximize the tax benefits for interest payments on their 2018 returns.
About Ken Berry
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a wide variety of newsletters, magazines, and other periodicals.