Unlock Mortgage Interest Deductions for Home Improvements

William H. Shawn

Co-Managing Partner, ShawnCoulson

Are you planning to take out a home equity loan or access a line of credit to make a significant home improvement? In the past, you could generally deduct the mortgage interest you incurred, within generous tax law limits. But the Tax Cuts and Jobs Act (TCJA) suspended the deduction for so-called “home equity debt” for 2018 through 2025.

Fortunately, there’s another tax-savvy option. If you meet certain requirements, you can squeeze through a tax loophole for “acquisition debt.” As a result, people who itemize deductions may be able to write off the full amount of qualified interest paid on a home equity loan or line of credit.

Old Rules

Before the TCJA, homeowners who itemized could deduct mortgage interest that qualified as either acquisition debt or home equity debt, within certain limits.

Acquisition debt. These proceeds are used to buy, build or substantially improve the home. (See “What Is Home Acquisition Indebtedness?” at right.) To qualify for the write-off, the loan must be secured by a qualified residence, such as your principal residence or a second home (for example, a vacation home). Interest was deductible on the first $1 million of acquisition debt ($500,000 for married people who file separately).

Home equity debt. When permissible by state law, a borrower could deduct the interest on home equity loans secured by a qualified residence, regardless of how the proceeds were used. With a home equity debt, deductions were limited to interest paid on the first $100,000 of debt ($50,000 for married people who file separately). Plus, the loan amount couldn’t exceed your equity in the home.

Along with other itemized deductions, mortgage interest deductions were subject to the Pease rule, which reduced itemized deductions for high-income taxpayers. The pre-TCJA rules are scheduled to go back into effect in 2026, unless the rules are modified again by Congress.

Current Rules

The TCJA tightens up the rules for the 2018 through 2025 tax years. Specifically, it includes these key changes:

  • The threshold for deducting interest paid on acquisition debt is lowered to $750,000 ($375,000 for married people who file separately) for loans originating after December 15, 2017 (April 1, 2018, if a binding contract was in place before December 16, 2017). Thus, some homeowners may be “grandfathered in” under the prior rules for acquisition debt.
  • The deduction for interest paid on home equity debt is generally suspended from 2018 through 2025. It doesn’t matter when you acquired the residence. For the time being, this change is scheduled to revert to prior law in 2026.

In conjunction with the other TCJA changes for itemized deductions, the Pease rule is suspended for 2018 through 2025. As with many other TCJA provisions affecting individuals, it’s scheduled to return in 2026, absent further legislation.

Threading the Tax Loophole

Despite these unfavorable changes, you still may be able to deduct mortgage interest paid on a home equity loan or line of credit. How? If you borrow money via a home equity loan or line of credit and use the proceeds for significant home improvements, the debt can be treated as an acquisition debt, instead of a home equity debt. Accordingly, you can add this mortgage interest to your deductible total if you itemize deductions.

For example, suppose you borrow $50,000 of home equity debt to put an in-ground pool in your backyard. This qualifies as a substantial improvement, so the mortgage interest paid on the loan is deductible as acquisition debt on your personal tax return, subject to the new dollar limit.

Just a small change in the way you handle things can salvage a deduction. Say that you were planning to use funds in a savings account to pay for a substantial home improvement. At the same time, you were contemplating a loan to help pay for your child’s college education. If you switch things around — that is, use a home equity loan for the home improvement and the cash in your savings account for college expenses — you can convert nondeductible interest into deductible interest, within the prevailing limits.

The IRS hasn’t officially issued a list of home improvements that would qualify as substantial improvements, but it’s clear that building an addition onto your home or finishing a basement will qualify. Some other possible examples of deductible home improvements are:

  • Putting a new roof on a home,
  • Replacing the HVAC system,
  • Remodeling a kitchen or bathroom, and
  • Resurfacing the driveway.

Important: No deduction is allowed for interest paid to make minor repairs. So, if you borrow money to fix a leak in the roof or replace a damaged mailbox, you won’t qualify for the write-off.

We Can Help

Consider the tax implications for any home improvements on the drawing board. Before you call in the demo crew or draw up a blueprint, contact your professional tax advisor to make sure you’re set to take advantage of all the tax breaks available under current tax law.

What Is Home Acquisition Indebtedness?

Under the tax law, home acquisition debt is a mortgage taken out “to buy, build, or substantially improve a qualified home.”  The debt also must be secured by that home.

An improvement is “substantial” if it:

  • Adds to the value of your home,
  • Prolongs your home’s useful life, or
  • Adapts your home to new uses.

Repairs that maintain your home in good condition, such as repainting your home, aren’t substantial improvements. However, if you paint your home as part of a renovation that substantially improves your qualified home, you can include the painting among the costs of the improvements.