How Tax Reform Impacted Housing Deductions

in Financial Planning by

Owning property has advantages and disadvantages – and certainly many of the issues are tax related. There are three important residential real estate taxation changes that last year’s tax reform impact. They include: mortgage interest deductions, property tax deductions, and capital gains tax exclusions.

Mortgage Interest Deductions

Before the 2018 tax reform, qualifying mortgage interest could be deducted on residential loans up to $1 million dollars. This loan cap applied to a maximum of two houses-a primary home and a vacation home. You were also allowed to deduct interest on an additional qualifying home-equity loan or home equity line of credit (HELOC) of up to $100,000. Under prior law, the loan must be secured for the taxpayer’s main or second home, and the interest paid on the home equity loan or home equity lines of credit could be used to pay personal living expenses, such as credit card debts.

The IRS recently clarified on February 21, 2018, that taxpayers can still potentially deduct interest on a home equity loan or a home equity line of credit as long as they are used to buy, build or substantially improve the taxpayer’s home that secures the loan. However, the interest expense on a home equity loan or a home equity line of credit used for anything other than these actions is no longer tax deductible.

Itemizing Deductions for Qualifying Home Mortgages

In the past, if you itemized your deductions, you would likely deduct the interest you paid on a qualifying home mortgage, which reduces your taxable income.. With the new tax law, many homeowners may no longer benefit from itemizing their deductions and instead can utilize the newly increased standard deduction amounts. If it still makes sense to itemize, however, just be aware the limit for deductible mortgage debt has decreased to $750,000. This applies to new loans taken out after Dec. 15, 2017. (If you have a loan from before that date, you are grandfathered in under the former limit of $1 million.) Additionally, if you refinance an existing loan that was in place prior to December 15, 2017, and as long as the indebtedness resulting from the refinancing does not exceed the amount of the refinanced indebtedness, you are still grandfathered in under the previous $1 million limit. You can also still deduct the mortgage interest on a second home, but this is subject to the same limits. If you have questions about whether the new tax law applies to you, check with a professional.

It’s interesting to note that many homeowners may not necessarily be impacted by this change. However, a cap of $500,000 in high-cost states, like California or New York, may be easily reached, even by those looking for relatively modest accommodations.

Capital Gains Exclusion

From a tax planning perspective, it’s also worth noting that the tax reform act preserved the home sale capital gain exclusion of up to $250,000 for individuals and $500,000 for married couples filing jointly. This means you can still potentially shield profits on qualified home sales up to these amounts from federal income tax.

If you sell a property you used as a primary residence for two out of the last five years, then you can take $250,000 (single) or $500,000 (married) of gains without paying capital gains taxes. If you have an investment property and have not lived in it for two out of the last five years, then you are subject to the full long-term or short-term gains if you decide to sell and take the profits. You may also be able to claim depreciation from a rental property to save on taxes. Make sure you have your CPA run the numbers so you are depreciating the right amount.

State & Local Property Taxes

Before tax reform, homeowners were able to deduct state and local (property) taxes from their federal tax bill. Now, if you are itemizing deductions on your tax return, then you may deduct property taxes you pay on your primary home as well as any other real estate you may own for personal purposes, but the deductions are limited to $10,000 (the total of state and local sales, income and property taxes are limited to the total $10,000) This change tends to impact certain markets. While homeowners in most parts of the country pay less than $10,000 annually in property taxes, taxpayers in states with high property taxes and high home prices could surely feel a wallet pinch.

Our Take

Whether you own real estate as a primary residence or as investment property, there are deductions and taxes to consider. Given the changes in tax law, many of these numbers have changed, which will impact previous and new homeowners alike. Make sure you consult with a professional to understand just how you’re impacted by these changes.

Learn more about taxes, housing, and how they fit into your holistic financial life by reading our free guide Personal Capital Tax Guide for Holistic Financial Planning.

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This blog is for informational purposes only; we are not in the business of providing specific tax or legal advice and we generally recommend seeking the advice and counsel of a tax professional before taking any action that may cause a material taxable event.

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Brian Wainscoat, CPA

Brian Wainscoat, CPA

As a tax specialist at Personal Capital, Brian brings a depth of tax knowledge that can be coordinated with clients’ tax planning strategies. Brian has an extensive background in tax preparation with high-net worth individuals, as well as business owners and specializes in optimizing tax efficiency for individual client situations. Brian is a Certified Public Accountant licensed in Colorado. He received his BA in Business Administration with an emphasis in accounting from Washington State University. In his free time, he enjoys spending time with his family and friends, bicycling, skiing, and volunteering and giving back to the community.

One Response

  1. Larry

    Brian…I turned 70-1/2 last year and become subject to the RMD. This resulted in my federal and state income taxes increasing 213% from the previous year. I’m particularly annoyed that Colorado is advantaged by this federal tax law. Because my RMD withdrawal is considered income (AGI) on my Colorado income tax return it gets taxed at 4.63%. As a result, my Colorado income tax was in excess of $8,000. Much higher than the Colorado average income tax. Nothing in my life changed, except for living to 70-1/2 and having saved for my retirement through my employers 401K plan. It appears that government likes to refer to the RMD as deferred taxation, with no concept of deferred consumption. Just think what I could have consumed 20 years ago, if I had not sacrificed for my retirement.

    Reply

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