Homeowners vs. Real Estate Investors: What the Changes in the Property Tax and Mortgage Interest Deductions Mean for You


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Trump’s new tax bill was signed into law, wrapped, and put underneath the tree just in time for Christmas, marking the biggest tax overhaul in over thirty years.

 

Nicholas Aiola, CPA - Homeowners vs. Real Estate Investors: What the Changes in the Property Tax and Mortgage Interest Deductions Mean for You - Trump America

 

If you find yourself in a panic and a bit of a haze trying to figure out what this all means for you, you’re not alone. One of the most common questions I’ve seen thus far is whether or not the new $10,000 cap on state and local taxes (SALT)/property taxes and reduced limits on the mortgage interest deduction apply to real estate investors. Let’s take a look…

 

Pre-2018 Tax Law

The following applies to your 2017 tax returns, which will be filed in 2018:

 

Homeowners

  • Property taxes – Deductible in full on Schedule A (you must itemize).
  • Mortgage interest – Deductible in full (on first and second mortgages) on Schedule A if your debt fits into any of the following categories (you must itemize):
    • The mortgage was taken out prior to October 14, 1987.
    • Mortgages that were taken out after October 13, 1987 total $1 million ($500,000 if married filing separately) or less (in the aggregate).
    • Home equity debt (not used to acquire your home) that was taken out after October 13, 1987 total $100,000 ($50,000 if married filing separately) or less. The interest is deductible no matter what the proceeds from the home equity debt is used for.

 

If your mortgage amount exceeds the limits in the second and third bullets above, your mortgage interest deduction would be limited based on the amount of your mortgage.

 

Investors

  • Property taxes on rental properties – Deductible in full on Schedule E against rental income.
  • Mortgage and home equity debt interest on rental properties – Deductible in full on Schedule E against rental income.

 

As you can see, there are no limitations for deducting property taxes and mortgage interest for real estate investors. If these deductions cause a net rental loss, the usability of that loss may be limited, however. But that’s a different discussion for a different day.

 

Post-2017 Tax Law

The following applies to your 2018 tax returns and beyond (read in a Buzz Lightyear voice), with some aspects set to phase out through or expire after 2025:

 

Homeowners

  • Property taxes – Limited to a $10,000 total deduction (including SALT deductions such as state and city withholdings from your W-2 job and estimated state and city tax payments) on Schedule A. You must itemize, but this limitation makes it much harder to do that.
  • Mortgage interest – Changes to the pre-2018 tax law are indicated below in bold font:
    • The mortgage was taken out prior to December 16, 2017.
    • Mortgages that were taken out after December 15, 2017 total $750,000 ($375,000 if married filing separately) or less (in the aggregate).
    • Home equity debt interest is no longer deductible unless you’re using the money for home improvements. This goes for new and old home equity loans.

 

Investors

  • Property taxes on rental properties – Deductible in full on Schedule E against rental income.
  • Mortgage and home equity debt interest on rental properties– Deductible in full on Schedule E against rental income.

 

That’s right – no change for investors; property taxes and debt service interest are still deductible in full against rental income.

 

Nicholas Aiola, CPA - Homeowners vs. Real Estate Investors: What the Changes in the Property Tax and Mortgage Interest Deductions Mean for You - Small House on Grass

 

Tracing Rules

Another popular question I’ve been asked is:

 

What happens if I take out a home equity loan or home equity line of credit (HELOC) and use the money to purchase an investment property? Will the interest be disallowed?

 

Good question.

 

The answer lies in the tracing rules.

 

This means that the deductibility of the interest depends on the use of the debt service proceeds, not the source. The money must be “traced”, or tracked, to figure the deductibility of the interest.

 

If the money was borrowed against your primary residence and you use the proceeds to treat yourself to a new car or take your family on a vacation, I have some bad news for you… None of that interest will be deductible.

 

If you use the money to buy an investment property, however, the money will be traced to the rental property and will be deducted in full on Schedule E against rental income.

 

For the skimmers, here’s the summary…

Starting in 2018, homeowners will be limited to a $10,000 total deduction for state, local, and property taxes, the mortgage interest limitation was lowered from $1 million to $750,000, and interest on home equity debt not used to improve your home will no longer be deductible.

 

For investors, nothing changes. You will still be able to fully deduct property taxes and mortgage/home equity interest against rental income.

 

Interest on home equity debt taken against your primary residence and used to buy investment properties will be fully deductible against rental income.

 

If you owner-occupy (“house hack”) your rental property, click here for more info on tax deductions related to you.

 

This is the tip of an extremely large iceberg. If you have any questions or would like to know how the new tax changes will affect you personally, reach out! I’m happy to help.

 

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Nick Aiola is a CPA located in New York, NY. Nick provides the highest quality of tax and accounting services to a wide range of clients, including individuals, businesses, and fiduciary entities.

 

Phone – (646) 397-9537

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