Home Equity Line of Credit (HELOC) and the New Tax Law: Understanding Deductibility and Tracing Rules

With the changes in tax laws, many homeowners are questioning how their home equity line of credit (HELOC) will be impacted. If you had a home equity loan for 15 years, and there was in and out activity every year, does the new tax law require you to analyze every transaction for 15 years to determine if your interest is still deductible under the new law? This article will provide a comprehensive guide to the new tax laws and how they apply to HELOCs.

Understanding the New Tax Law and HELOC Deductibility

The new tax law, effective as of December 15, 2017, has introduced several changes that affect the deductibility of interest on home equity lines of credit (HELOCs). The law has introduced a so-called 'tracing' requirement for certain HELOC transactions.

Tracing Rules for HELOC Interest Deductibility

Under the new tax law, home equity lines of credit require tracing rules as of December 15, 2017. This means that if you use the proceeds from a HELOC to make personal expenditures such as buying a boat or going on a vacation, the interest on that portion of the loan is no longer deductible. However, the law grandfathered existing debts closed in 2018 and later under the old rules, as long as the debt was initiated before 2018.

Date of Purchase and Deduction Eligibility

Date of Purchase: The new law distinguishes between the date of the purchase of assets financed by the loan and the date the loan was initiated. For assets financed after December 15, 2017, the interest on the loan portion used to finance these assets is not deductible. This includes, but is not limited to, expenditures such as home renovations, education, or personal entertainment.

Existing Debts and Grandfathering

Grandfathering: If the loans were initiated before December 15, 2017, they are grandfathered under the old rules and the interest can still be deducted, even if the assets are purchased after this date. The grandfathering applies to debts that were closed in 2018 and later, provided they were initiated before 2018. Thus, the amount of interest you can deduct is linked to when the loan was initiated rather than when the assets were acquired.

Application of Tracing Rules and Examples

Let's illustrate this with an example. Suppose you had a HELOC loan initiated in 2016 and you had regular in and out activity. If you use part of the loan to buy a vacation home or a luxury car and these purchases are made after December 15, 2017, the interest on that portion will be non-deductible. However, if the same loan was initiated in 2016 and the assets (vacation home or car) were bought before December 15, 2017, the interest on the loan is deductible.

Practical Implications for Homeowners

For homeowners who have had an ongoing relationship with a HELOC and have seen in and out activity, it is crucial to understand the new tax law and its implications. If you decide to refinance or take out a new loan, you may want to do so before December 15, 2017, to ensure that the loan is grandfathered under the old rules. After this date, the interest on new loans or transactions where the loan proceeds are used for personal expenditures is not deductible.

Conclusion

The new tax law introduces complex tracing rules for HELOCs, which can significantly impact the deductibility of interest on these loans. Understanding the distinction between the date of loan initiation and the date of the asset purchase is key. Providing clarity on this matter is essential for homeowners who are contending with both existing and new HELOCs. As always, consulting with a tax advisor is recommended to ensure compliance with all relevant tax laws.

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Additional Resources

To learn more about HELOCs and the new tax law, consider consulting the , where you can find official IRS guidelines and FAQs.