While the new Tax Cuts and Jobs Act (TCJA) adversely shifts the playing field for home mortgage interest deductions, all is not necessarily lost. Many homeowners will be blissfully unaffected because “grandfather” provisions keep the prior-law rules in place for them.

That said, many homeowners will be adversely affected by the TCJA provision that for 2018-2025 generally disallows interest deductions for home equity loans. Once again, however, all is not necessarily lost. The little-known fact is that you still deduct home equity loan interest in certain circumstances. I’ll explain when after first covering the necessary background information.

Prior law: the ‘good old days’ for mortgage interest deductions

Before the TCJA, you could claim itemized qualified residence interest deductions on up to $1 million of home acquisition debt (meaning mortgage debt incurred to buy or improve your first or second residence and that is secured by that residence), or $500,000 if you used married filing separate status.

Under prior law, you could also claim itemized qualified residence interest deductions on up to $100,000 of home equity debt for regular tax purposes, or $50,000 if you used married filing separate status, regardless of how you used the loan proceeds. For Alternative Minimum Tax purposes, however, you could only deduct the interest if the home equity loan proceeds were used to buy or improve your first or second residence.

TCJA change for home acquisition debt

For 2018-2025, the TCJA generally allows you treat interest on up to $750,000 of home acquisition debt (incurred to buy or improve your first or second residence and secured by that residence) as deductible qualified residence interest. If you use married filing separate status, the debt limit is cut to $375,000.

TCJA change for home equity debt

For 2018-2025, the TCJA generally eliminates the prior-law provision that allowed you to claim itemized qualified residence interest deductions on up $100,000 of home equity debt ($50,000 for those who use married filing separate status).

Grandfather rules for up to $1 million of home acquisition debt

Under one grandfather rule, the TCJA changes do not affect up to $1 million of home acquisition debt that was taken out: (1) before Dec. 16, 2017 or (2) under a binding contract that was in effect before Dec. 16, 2017, as long as your home purchase closed before April 1, 2018.

Under a second grandfather rule, the TCJA changes do not affect up to $1 million of home acquisition debt that was taken out before Dec. 16, 2017 and then refinanced later — to the extent the initial principal balance of the new loan does not exceed the principal balance of the old loan at the time of the refinancing.

Home equity loan FAQs

With all that background information in mind, let’s now focus on when you can and cannot claim itemized qualified residence interest deduction on home equity loans for 2018-2025 under the new TCJA rules. Here are some questions and answers. Some of the answers may surprise you — in a good way.

Q: I took out a $100,000 HELOC this year. I spent the proceeds to pay off credit card balances, car loans, and student loans. Can I deduct the interest on my 2018 return?

A: This is one situation where the answer is a clear no, because you did not spend the loan proceeds to buy or improve your first or second home. So your HELOC is classified for tax purposes as home equity debt. For 2018-2025, you cannot treat interest on home equity debt as deductible qualified residence interest. Sorry.

Q: Can I still deduct the interest on my $100,000 home equity loan that I took out before the new tax law?

A: Maybe. If you did not spend the proceeds to buy or improve your first or second residence, the answer is no, because you can no longer deduct interest on a mortgage loan that is classified for tax purposes as home equity debt.

But if you spent the $100,000 of home equity loan proceeds to buy or improve your first or second home, it may be a different story. If you have less than $900,000 of first-mortgage acquisition debt, you can treat the $100,000 home equity loan as additional home acquisition debt that does not exceed the $1 million limit for grandfathered pre-TCJA home acquisition debt. If this is your situation, you can treat the interest on both loans as deductible qualified residence interest.

Q: I took out a $500,000 first mortgage to buy my main home this year. Later, I took out a $250,000 home equity loan to pay for an addition to my main home. Can I deduct the interest on both loans?

A: Yes. You can treat both loans as acquisition debt the combined balance of which does not exceed the TCJA limit of $750,000. So you can treat the interest on both loans as deductible qualified residence interest.

Q: I took out a $500,000 first mortgage to buy my main home this year. That loan is secured by my main home. Later, I took out a $250,000 loan to buy a vacation home. That loan is secured by the vacation home. Can I deduct the interest on both loans?

A: Yes, because the combined balances of the two loans does not exceed the $750,000 TCJA limit for home acquisition debt.

Variation: If you instead took out a $250,000 home equity loan against your main home to buy the vacation home, the IRS says the interest on the home equity loan does not qualify as acquisition debt, because it is not secured by the vacation home. Therefore, according to the IRS, the home equity loan is classified as such for tax purposes, and you cannot treat the interest on that loan as deductible qualified residence interest, according to the IRS Information Release IR2018-32.

Q: I took out an $800,000 loan to buy my main home last year. This year I opened up a HELOC and borrowed $80,000 to remodel my bathrooms. How much interest can I deduct for 2018-2025?

A: You can treat the interest on the first mortgage as deductible qualified residence interest under the grandfather rule for up to $1 million of pre-TCJA acquisition debt. However, because your $80,000 HELOC was taken out in 2018, the TCJA $750,000 limit on acquisition debt apparently precludes any deductions for the HELOC interest. That’s because the entire $750,000 TCJA limit on acquisition debt was absorbed (and then some) by your grandfathered $800,000 first mortgage. So the HELOC apparently must be treated as home equity debt, and interest on home equity debt cannot be treated as deductible qualified residence interest for 2018-2025.

Q: I took out a $650,000 loan to buy my main home last year. This year I opened up a HELOC and borrowed $80,000 to remodel my kitchen. How much interest can I deduct for 2018-2025?

A: You can treat all the interest on the first mortgage as deductible qualified residence interest under the grandfather rule for up to $1 million of acquisition debt. The $80,000 HELOC balance also can be treated as acquisition debt, because the combined balance of the first mortgage and the HELOC is only $730,000, which is under the $750,000 TCJA limit. So you can treat the interest on both loans as deductible qualified residence interest for 2018-2025.

The bottom line

These FAQs illustrate how the TCJA rules for deducting home mortgage interest apply in just a few situations. As you can see, it can get complicated. Sorry about that.