Whether you bought a starter cottage in the country or a mini mansion in the suburbs, there was one thing you could always count on as a homeowner: tax breaks. While property-related deductions haven’t gone completely by the wayside, the arrival of the new tax law does curb them pretty significantly. If you own a home or are planning to buy one this year, here are the biggest tax-law changes for homeowners that could impact your tax returns starting this year.
LIMITS TO THE MORTGAGE INTEREST DEDUCTION
Previously, you could deduct the interest you pay on any home loan up to $1 million. Now, that threshold has been lowered to $750,000. While interest is deductible on your primary home and a second home, the $750,000 is a cap for the combined mortgages.
The good news? This change only applies to new mortgages on homes purchased on or after December 15, 2017 — if you owned your home prior to that date, you’re grandfathered into the $1 million limit. The bad news? If you were planning to buy a new home this year in a pricey housing market, you’re not going to enjoy the same kind of tax break that you would have before. That could factor into your decision on whether it’s the right time to buy, or how much you should put down.
“Remember that the cap is on loans of up to $750,000, so if you are borrowing less than that you can deduct all your mortgage interest,” says Patrick Horning, an advanced planning attorney with Northwestern Mutual. “Putting down a larger down payment would help keep down the size of your loan.”
LIMITS TO THE HOME-EQUITY LOAN INTEREST DEDUCTION
The interest you can deduct on home-equity loans is also folded into the new $750,000 loan limit — but there’s a catch. You can only deduct that interest if you use the money to buy, build or improve upon your home. So if you use a home equity loan to build a new deck in your backyard, then the interest on that loan can be deductible. But if you use that loan to, say, pay off credit card balances, the interest is not deductible.
This is a change from previous years, when you could deduct home-equity loan interest no matter what you used the money for. “Homeowners would often use their home equity loan as an emergency fund, or a way to fund their kids’ colleges or buy a new car, then take the deduction on that interest,” says Mary Lee Odem, assistant director of planning and sales for Northwestern Mutual. “But a lot of people were using the loan in a way that it wasn’t originally intended.”
If you’re not using a home equity loan for property-related reasons, you may be able to consolidate that loan into your mortgage in order to be able to deduct the interest. But the bigger picture concern “is that you have to think about how you use a home-equity loan, and whether it’s worth it to take on that debt,” Odem says.
THE CAP ON STATE AND LOCAL PROPERTY TAX DEDUCTIONS
Starting this year, you can only deduct up to $10,000 in state and local taxes (SALT). That includes your property taxes as well as what you pay in state income tax or sales tax. Previously, there was no cap on the amount of SALT deductions you could take, so this significantly limits deductions for homeowners in high property-tax states.
The cap also means you’ll have to make some strategic decisions about when it makes sense to itemize your deductions or take the standard deduction, which has doubled to $12,000 for individual filers and $24,000 for married couples filing jointly. One strategy for those living in a state with lower property taxes could be paying two years’ worth of property taxes in a year when you want to itemize your deductions, then taking the standard deduction in the off year, Horning suggests.
WHAT HOMEOWNERS SHOULD KEEP IN MIND
Even though these tax-law changes may seem like a disincentive to buy a home right now, remember that, unless Congress takes further action, these provisions will actually sunset at the end of 2025 — and they only apply to personal residences. “Tax laws haven’t changed much for people with rental properties, so you can still take advantage of the tax breaks there,” Odem says. This could provide an incentive to turn a second home into an income property.
Also, for those looking to sell their homes this year, the home-sale exclusion rule hasn’t gone anywhere: Married couples filing jointly can exclude up to $500,000 of their home-sale gains (or $250,000 for single filers) from their total capital gains for the year, assuming they’ve lived in their homes for at least two of the past five years. That’s still a major break on capital gains tax for homeowners.
Overall, remember that tax incentives are just one reason to buy — if your heart is set on getting your dream home this year, don’t make a decision based solely on your tax situation. Talk to your financial advisor to determine if the time is still right to take the homebuying plunge.
This article is not intended as legal or tax advice. Northwestern Mutual and its financial representatives do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent legal, accounting or tax adviser.