This is the second installment of our monthly tax blog around the new Tax Cuts and Jobs Act passed into law last December. In our first blog post, we discussed the changes in the tax rates for individuals as well as the changes in the exemptions and standard deductions.
In this blog post, we will continue to discuss changes that will have an impact on individual taxpayers. The changes discussed here mainly relate to changes to deductions allowed on Schedule A for those individuals who use itemized deductions rather than the standard deduction.
Changes to Itemized Deduction
State and Local Tax Deduction
Prior to the change in the tax law, individual taxpayers were allowed deduct on Schedule A state taxes paid. These taxes included income or sales tax (you could deduct one or the other, but not both) paid to a state. In addition, individuals were allowed to deduct state and local property taxes paid during the tax year. Finally, under the prior law, there was no cap or ceiling on how much a taxpayer could deduct for the state and local taxes.
For example, if an individual paid $50,000 in state income taxes and $15,000 in property taxes, the individual could deduct $65,000 in state and local taxes. This example does not take into consideration the effects of the overall limitations on Schedule A deductions or whether the taxpayer must pay alternative minimum tax.
The new tax law now puts a cap or ceiling on the amount an individual can deduct for state and local taxes as well as property taxes. The ceiling or limitation is now $10,000. This means the maximum amount of state, local, and property taxes combined is $10,000. In regards to my example above, in 2018 the individual taxpayer would be limited to $10,000 deduction rather than the $65,000 deduction under the old law.
This change in the tax law is effective for tax years 2018 through 2025. In addition, this only applies to individuals who itemized their deductions. It does not effect property or state taxes deducted against rental income reported on Schedule E, business income reported on Schedule C, or farm income reported on Schedule F.
Mortgage Interest Deduction
For tax years beginning in 2018 through 2025, the deduction for home mortgage interest is limited to interest on loans of up to $750,000 used to acquire or renovate a primary residence. In addition, the deduction for interest on home equity indebtedness (i.e. HELOC) is suspended.
Prior to the tax law changes, individuals were allowed to deduct interest on loans of up to $1,000,000 for a home acquisition (excluding limitations on home equity indebtedness). For example if an individual purchased a home with a loan of $1,000,000 he or she could deduct the entire amount of interest paid on that loan. However, if the loan was $1,500,000, the individual could only deduct two thirds ($1,000,000 / $1,500,000) of the overall interest paid.
Under the new law the limit on the home loan is now $750,000 rather than $1,000,000.
There are a couple of things to keep in mind with this tax law change and that is the $750,000 limit only applies to loans acquired after December 15th, 2017. Therefore, if a taxpayer had a mortgage of $850,000 prior to December 15th, 2017 and still has that mortgage, the taxpayer can deduction 100% of their mortgage interest.
However, that is not the case when it come to the home equity indebtedness (i.e. HELOC) secured by your home. In this case, no interest deduction is allowed for home equity indebtedness for 2018 through 2025 even if the home equity indebtedness was acquired prior to December 15th, 2017. The only caveat to the new tax law disallowing the deduction for interest on home equity indebtedness is that if the home equity indebtedness was incurred to purchase the primary residence or used to make improvements to your primary residence, then it is deducted (within the limits). If the HELOC was used to purchase a car or pay for a vacation the interest will not be deductible.
Finally, these limitations only applied to interested deductions on Schedule A. Interest deductions for rental properties reported on Schedule E are not affected by this tax law change.
Miscellaneous Itemized Deductions
The final major change to itemized deductions relating to the new tax law is that individuals are no longer allowed to deducted miscellaneous itemized deductions, that are subject to the 2% of adjusted gross income, for tax years 2018 through 2025.
Miscellaneous itemized deductions include but are not limited to deductions for:
1. Unreimbursed employee expenses;
2. Job-hunting expenses;
3. Tax preparation fees;
4. Investment advisory fees;
5. Safety deposit box fees;
6. Union dues;
This means that such deductions will not be deductible.
In general, the combination of these three tax law changes should reduce the amount of itemized deductions taxpayers will take in tax years 2018 through 2025 and can have a negative impact on an individual’s overall taxes (i.e. raise taxes).
There is planning that can be done to minimize the impact of these tax law changes (i.e. managing state taxes, timing of charitable contributions and other deductions, etc). If you have questions about how these tax law changes will affect you, please contact us here at Isler and we can help answer your questions and assist you with any planning that may need to be done.
These are only three of the many tax law changes that occurred with the signing of the 2017 Tax Cuts and Job Act. Make sure to check back for future blog posts about additional changes and how those changes can affect your tax situation.