Historically, the two big federal tax benefits enjoyed by homeowners are the Mortgage Interest Deduction and the Deduction for State and Local Taxes (SALT).
Mortgage Interest Deduction
Generally, personal interest paid on debt is not deductible for federal tax purposes. However, under the old tax law, homeowners could deduct their annual mortgage interest paid on their mortgage principal balance up to $1,000,000. This provides a big tax benefit to homeowners.
The bad news is that for any new mortgage debt on or after 12/15/2017, this principal balance limitation is reduced from one million to $750,000. The good news is that the House had originally reduced this limitation to $500,000! Fortunately, the Tax Cuts and Jobs Act (“TCJA”) provides for the more generous $750,000 limitation.
More good news! For debt in place before 12/15/2017, the full deduction remains in place as “grandfathered debt.” This is the case even if you refinance that pre-existing debt. As long as you refinance for the same amount, or less, you will continue to enjoy a deduction of mortgage interest based on the higher $1 million of principal.
Historically, homeowners could also deduct their home equity interest on another $100,000 of debt as long as that debt was used for home improvements. Unfortunately, this deduction no longer exists under the new tax law. That goes for preexisting home equity interest and new home equity interest. In other words, this type of debt received no “grandfathered” protection for any such deduction for tax years after 2017.
Deduction for State and Local Taxes (SALT)
The new limitations on the Deduction for SALT may be a big hit to many homeowners in highly taxed states such as California. Under the old tax law, an unlimited deduction was allowed for all state and local taxes paid during the year. This includes state income taxes, sales taxes and property taxes. Under the TCJA, this federal deduction is now limited to a total maximum of $10,000. Most of us in California pay substantially more than $10,000 in combined CA income tax and county property tax. Unfortunately, this $10,000 is the limit for single and married couples and the amount is not indexed for inflation so it will not grow each year. It is just a flat limit of $10,000. This may sound harsh because it is. However, the original House and Senate bills had removed this deduction completely so at least a $10,000 benefit has been salvaged.
It is important to understand that for many high-income taxpayers, this is not really a loss of deductions at all since, if you are subject to the Alternative Minimum Tax (AMT), you are not currently enjoying a SALT deduction anyway. You may have heard of AMT but you may not be aware of how it works because it is a bit complicated. If you have an amount other than zero reflected on line 45 of your 2016 IRS Form 1040, you are in AMT and you are not currently receiving any benefit of your state and local tax deductions. See fuller discussion of AMT in article 5 of 6.
But, watch for more tax information for homeowners in our third of 6 articles first.