The IRC section 163 regulated that taxpayers can enjoy interest deduction on qualified indebtedness within the taxable year. Interest deduction brings taxpayers paying certain types of interest a reduction in taxable income. According to the Topic Number 505 (2019), types of interest deductible as itemized deduction include qualified mortgages and home equity loans interest.
Home mortgage loans refer to the mortgage loan that a resident applies to a bank when he purchases a house. The amount of the loan is the difference between the house price and the down payment. The home equity loan is the net value of housing loans, and the loan amount is generally the difference between current market value of the house and the mortgaged loan of the house. Home equity loans can be used for unlimited purposes and are mainly loans for consumption purpose.
Home mortgage interest is fully deductible only if all mortgages taken out on or before October 13, 1987, otherwise, there would be limitation on deductible home mortgage interest. For mortgages taken between October 13, 1987 and December 16, 2017, one could deduct his home mortgage interest on the first $1 million or less indebtedness (the amount of home acquisition debt plus grandfathered debt). If the married filing separately, the limitation would narrow to $ 500,000. The home acquisition debt refers to the debt used for the purpose of buying, building, or substantially improving one’s home. The grandfathered debt is mortgage that took out on one’s home before October 14, 1987. However, in many cases, a mortgage secured by a qualified home could be deemed as the deductible home acquisition debt, even though one might not use these loans to buy, build, or substantially improve the home. All grandfathered debt is deductible, but the debt would reduce the deductible limitation for home acquisition debt.
According to the Tax Cuts and Jobs Act, beginning in 2018, taxpayers can get full home mortgage or home equity loan interest deduction, only if throughout the year of the grandfathered debt plus home mortgages totaled no more than $750,000 ($ 375, 000 if married filed separately) (Publication 936, 2018). As for the home equity loans, the Tax Cuts and Jobs Act suspends the deduction for interest paid on home equity loans, unless these loans are used to purchase, build or substantially improve the taxpayer’s home (IRS News, 2018). Interest deduction is allowed only when these loans are under the debt limits and secured by a home.
In terms of John’s situation, he is married and filing together with his wife, and therefore he could enjoy home mortgage interest deduction on the first $750, 000 of indebtedness. Given that he currently has a mortgage of $ 500,000, Johan can hold another $ 250, 000 home mortgage or home equity loans. Furthermore, it is noteworthy that if John were going to ensure loan interest deduction, he had to limit the uses of these loans to purchase, build, or substantial home improvement. These loans could increase the amount of funds available for the education of John’s Children, however, John should realize that mortgage or home equity loans for the purpose of education are not deductible according to current tax codes.