The new tax law creates some potential pitfalls for home buyers and how they finance their property.
Much of whether interest on the mortgage can be deducted comes down to whether the loan is considered “acquisition debt.” Timing is everything.
Pay cash for your home — whether for your primary residence or a second home — and decide later to get a mortgage? It won’t qualify for a deduction because the loan wasn’t used to buy the property from the start. Nor can you get around that with a home-equity loan. Under the old rules, you could deduct the interest associated with up to $100,000 of home-equity debt regardless of when you got the loan.
Here are three more examples that illustrate the complexity of the rules that took effect at the start of this year:
• If you buy a second home and take out a mortgage at the same time, the interest is fully deductible if you itemize — and if the mortgages on both the primary and secondary home don’t exceed a combined $750,000. That limit applied to all taxpayers, except married couples filing separately, who are each limited to $375,000.
Single taxpayers are each subject to the $750,000 limit. A Ninth Circuit Appeals Court decision ruled that if an unmarried couple buys a home, they can pool their caps, which would mean they could deduct interest on a mortgage of up to $1.5 million.
Under the old rule, the deductible interest was limited to the combined mortgage of up to $1 million for all taxpayers, except for married taxpayers filing separately, who were limited to $500,000 each.
• How about if you buy that same second home but get the cash to pay for it by taking a second mortgage on the primary residence? Then interest on the second mortgage isn’t deductible, even if the combined mortgages don’t top $750,000. And if the secondary residence is funded with both a second mortgage on the primary residence and a mortgage on the secondary residence, only the interest on the secondary residence’s mortgage is deductible, again up to that $750,000 limit for both mortgages.
• Likewise, if a primary or secondary residence is funded with both a primary and secondary mortgage at the time of purchase, the interest from both mortgages would be deductible up to the combined $750,000 limit because both mortgages were part of the purchase.
The old limit of deducting interest on mortgages of up to $1 million still applies to homes bought before Dec. 15. But if the second home is purchased after that date, when this part of the Tax Cuts and Jobs Act of 2017 took effect, then the combined limit is $750,000 if the outstanding mortgage on the primary residence is below $750,000.
If the outstanding mortgage on the primary residence is above $750,000, then interest on the primary residence is still deductible but...