Mortgage Deduction Strategies Under The Tax Reform

January 31, 2018 — Leave a comment

Quiz!

Which of the following are true?

  1. You cannot deduct interest on any mortgage above 750k.
  2. You can only deduct interest on a mortgage above 750k if the mortgage was established before 12/15/2017.
  3. You can deduct interest on a mortgage above 750k only if its lowest balance before the tax reform was over 750k, and even if you refinanced it since then.
  4. You can deduct interest on a mortgage above 750k for any mortgage that was taken before the tax reform.
  5. You may get a deduction on mortgage interest, for mortgages above 750k, regardless of when the mortgage was taken.

Mortgage Deduction Strategies Under The Tax Reform

The tax reform that was signed on 12/22/2017 (Tax Cuts and Jobs Act), reduces the mortgage deduction from $1M to $750k and eliminates the home equity debt interest deduction of $100k. This article presents how it can impact you, and strategies for lessening the impact.

  1. Enjoy Grandfathering: While new mortgage debt above $750k does not get a tax deduction, you can continue to enjoy up to $1M deduction on existing mortgages & loan amounts preserved through refinances. Strategy: Refinance with a larger and/or interest-only mortgage, and keep refinancing to keep the mortgage from dipping below $1M (or below your existing balance between $750k and $1M). Examples for the grandfathering:
    1. You took a 1M mortgage in the past and by 2017 the balance was down to 600k. Deductions on future refinances will be limited to interest on 600k, even if you increase the borrowed amount. If the balance goes down to 500k in 2020, deductions through future refinances are limited to interest on 500k.
    2. You took a 1M mortgage in the past and by 2017 the balance was down to 900k. If you refinance to 1.2M, you keep getting a deduction on interest on 900k, as long as the balance is over 900k.
    3. You took a 2M mortgage in the past and by 2017 the balance was down to 1.5M. The balance keeps declining to 1.4M by 2018, and then you refinance with a 2.2M mortgage. At all times, you get to enjoy the full deduction of interest on 1M.
  2. Get Investment Interest Expense Deduction: Whether you have a new mortgage above $750k, an old mortgage above $1M, or a HELOC (Home Equity Line of Credit), you may be able to get a partial or full deduction vs. investments income (interest, dividends or capital gains). This deduction is called “Investment Interest Expense”, and is given because you technically borrow to invest, whether you intended to do so or not. This is evident if you compare your current reality relative to selling from your investments to pay off your home loans. By keeping both the loan and the investments, you are borrowing to invest. A few notes:
    1. The deduction is available regardless of the source of investment income. For example, if you have a $100k HELOC costing you $5k per year in interest, and a $500k investment generating 1% realized annual income = $5k, you can use that.
    2. If you don’t have enough investment income in any given year, you can defer the disallowed interest amount to the next year, and continue to do so indefinitely. If your investment has high average growth and generates income and/or capital gains, you may have a chance of enjoying the disallowed deduction later on.
    3. Taking the deduction vs. investment income that is taxed at your marginal tax rate (i.e. short-term gains & non-qualified dividends) gives you the full benefit, like the mortgage & HELOC deductions.
    4. If you don’t have enough of the ideal investment income mentioned above, you can elect to take deductions vs. long-term gains & qualified dividends. You have to decide whether taking the lesser deduction today is better than the full deduction later on, requiring some analysis. This decision may not apply to state taxes where there is the same tax rate for both types of investment income.

Important notes:

  1. You should only borrow to invest if the investments are likely to provide materially higher growth than the interest on your loans, or you are seeking liquidity as part of your risk plan and willing to accept the interest costs.
  2. Do a very careful risk analysis that prepares you for a great deal of bad luck. Don’t forget what happened to those who skipped this step in 2008.
  3. You need perfect discipline through the market cycles. The best risk analysis won’t protect you if you panic-sell at the bottom of a decline.
  4. Always do a full comparison of the current picture vs. the new one you are considering, to see if the change is beneficial. The most common failure results from considering one or two factors in isolation, without the remaining moving parts. For a refinance, start with risk planning, then include: estimated refinance costs, change in rate, impact of cash flow change (e.g. between interest-only and fully amortized), and any change in tax benefits. Sometimes the decision will be simple, and sometimes it will require a full simulation in a spreadsheet.

Also, remember that I am not a CPA, and I recommend consulting with a CPA on all tax matters.

Quiz Answer:

Which of the following are true?

  1. You cannot deduct interest on any mortgage above 750k.
  2. You can only deduct interest on a mortgage above 750k if the mortgage was established before 12/15/2017.
  3. You can deduct interest on a mortgage above 750k only if its lowest balance before the tax reform was over 750k, and even if you refinanced it since then. [Correct Answer]
  4. You can deduct interest on a mortgage above 750k for any mortgage that was taken before the tax reform.
  5. You may get a deduction on mortgage interest, for mortgages above 750k, regardless of when the mortgage was taken. [Correct Answer]

Explanations:

  1. If the mortgage was taken before the tax reform and was kept or refinanced to a similar/higher balance, you can get a deduction up to 1M.
  2. If you refinance a >750k mortgage and keep the balance higher than 750k, your deduction is grandfathered.
  3. Old borrowed amounts are grandfathered. Specifically, as long as you sustained your mortgage balance above 750k, you get to keep the deduction on interest up to 1M. This holds even through refinances.
  4. Not true if the mortgage balance went below 750k at any point.
  5. A bit tricky, and is true because you can get a partial or full investment interest expenses deduction on disallowed mortgage interest amount, depending on your investment income. The article explains this further.
Disclosures Including Backtested Performance Data

Subscribe to our mailing list

* indicates required Email Address * First Name Last Name

Gil Hanoch

Posts

No Comments

Be the first to start the conversation.

Leave a Reply