Your interest expense deduction rules are changing

Your Guide to State, Local, Federal, Estate + International Taxation

interest expense, tax reform, IRSThere are three new rules that may affect your interest expense deductions for the 2018 tax filing year. These new rules generally apply to the dates of January 1, 2018 through December 31, 2025. The new rules affect mortgage interest expense, investment interest expense and business interest expense.

Mortgage interest expense

Under the old rules, you could generally deduct as an itemized deduction the full amount of your mortgage interest expense as long as your acquisition indebtedness (amounts borrowed to buy, build or improve your home) plus your home-equity indebtedness (amounts borrowed that were secured by your home) combined did not exceed $1,100,000. From January 1, 2018 through December 31, 2025 a new set of rules apply:

  • Was your acquisition indebtedness borrowed on or before December 15, 2017? Interest is deductible using the old limit debt limit of $1,000,000.
  • Is it new acquisition indebtedness after December 15, 2017? Mortgage interest expense is limited to debt up to $750,000.
  • Also changed under the new laws – your home equity interest is no longer deductible (unless debt qualifies as acquisition indebtedness). So, interest on home equity loans used to buy a car, boat, etc. is no longer deductible as qualified mortgage interest.

Investment interest expense

Interest paid on debt allocable to property held for taxable investment qualifies as investment interest expense. You can deduct this interest expense as an itemized deduction subject to certain limitations.

Prior to 2018, your investment interest expense deduction was limited to your a) investment income less b) deductible investment expenses (such as investment fees, custodial fees etc.)

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Under the new tax law, miscellaneous itemized deductions are no longer deductible. This includes most investment expenses.

The outcome: your investment interest expense deduction is now only limited to your investment income.

Business interest expense limitation

Before we get into what this limitation is, I want to point out that it does not apply to:

  • Small taxpayers, defined as taxpayers with average annual gross receipts of $25 million or less for the three-year period ending with the prior tax year
  • Taxpayers in certain trades or businesses that are excepted such as utilities
  • Taxpayers that can elect to be excepted for purposes of this limitation, such as real property businesses

Okay, so what is the business interest expense deduction? This is any interest paid or accrued on indebtedness appropriately allocable to a trade or business. Up to December 31, 2017, this interest was deducted before your taxable income was calculated.

Under the new law, the business interest expense deduction may be limited for taxpayers subject to the new rule. How? Your interest deduction is a) limited to business interest income plus b) 30% of the adjusted taxable income plus c) business floor plan financing income. Adjusted taxable income for this purpose includes adding back depreciation, amortization and interest expense, as well as other items.

The amount of interest expense exceeding the limitation amount can be carried forward indefinitely. There are additional limitations regarding partnerships and S Corporations.

Be sure to consult your Henry+Horne tax advisor for more information.

Meghan Scott, EA