Home equity debt: Still deductible? It depends

ALBUQUERQUE, N.M. — Q: I have read conflicting statements about the treatment of home equity debt in 2018 and beyond. One website says that interest on home equity debt is no longer deductible. Another says it is deductible only if used to finance improvements to the home. Can you clarify which is true? I am considering a home equity loan and need to know if I can still deduct the interest if I make improvements to the house.

Both sites could be viewed as correct. The answer is based on the way that the tax law defines words, which is not the way that many other people define words.

I often use casual language in place of technical tax terms when writing for audiences other than tax professionals. Language that would be inexcusable with other tax professionals is often best for other audiences to avoid unnecessary confusion.

In this case, casual use of tax terminology has created a problem. The correct answer is that beginning in 2018 and continuing through 2025, interest on home equity debt is no longer deductible. The issue is what is meant by home equity debt.

The tax law has two types of debt that is secured by a home. Acquisition debt means the proceeds of the loan were used to acquire, construct, or improve the home. Home equity debt means the proceeds were either used for some other purpose, or the principal of the acquisition debt exceeds a statutory limit of $750,000.

Acquisition debt interest remains deductible (you must itemize deductions). Home equity debt interest is not deductible.

A lender may call a loan “home equity.” That means nothing for tax purposes. If the proceeds of the loan are used to improve the home, the loan is an acquisition loan. If a loan is classified as acquisition debt, it cannot be home equity debt.

So the statement that interest on home equity loans is no longer deductible is correct. The statement that interest on a loan that the lender calls a home equity loan remains deductible is also correct if the loan proceeds are used to improve the home.

The difference is in how a lender refers to a loan and how the tax code refers to that same loan. If the loan proceeds are used to improve the home, the tax code says the loan is acquisition debt and, if acquisition debt, it is not home equity debt.

So the lender calls the loan home equity debt and that name does not apply to the tax classification of the loan or the interest on the loan. The interest is deductible as acquisition debt interest.

Q: I own an interest in a partnership that has experienced losses, so my form K-1 shows that I have a negative balance in my capital account of $18,433. I have an offer to sell the interest for the buyer’s agreement to assume my share of the partnership debt and to pay me $25,000 per year for the next five years. I am trying to figure out how much tax I will have to pay.

I have to make the assumption that the capital balance you refer to is a “tax basis” capital account. The K-1 form will have a box checked to confirm this.

Your sale is called an installment sale because at least one payment is received in a year other than the year of sale. Generally, installment reporting allows you to defer reporting gain until payments are received. You then report gain in proportion to the percentage of proceeds received in each year.

In your case, that would mean 20 percent of the gain is reported this year and in each of the next four years. But you have a special problem because of the negative tax basis capital. You have liabilities in excess of basis in the amount of $18,433.

In an installment sale, this causes you to recognize the $18,433 gain in the year of sale without any link to an actual payment. Then every dollar received each year, including this year, is all gain.

So, you will have $43,433 of gain in 2018 if the sale closes this year and $100,000 deferred over the next four years.

James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.