This past week, the IRS offered guidance on its website on the new restrictions placed by the Tax Cuts and Jobs Act (“TCJA”) on the home mortgage interest deduction.
The guidance is noteworthy for the U.S. expat community, because when it comes to the home mortgage interest deduction, the tax code does not distinguish between a home in the U.S. and a home abroad. In appropriate circumstances, the mortgage interest deduction can be an important tax saving method for citizens living abroad.
The Home Mortgage Interest Deduction
The tax code allows a mortgage interest deduction provided certain basic requirements are met. These requirements generally are:
(i) the mortgage must be a loan secured by a qualified home in which you have an ownership interest; and
(ii) a qualified home is either your primary residence or a second home.
Restrictions Under The TCJA
Starting with the 2018 tax year, a new lower dollar limit of $750,000 applies to mortgages for purposes of qualifying for the home mortgage interest deduction. The limit is half that amount ($375,000) for a married taxpayer filing a separate return.
Prior to the tax reform, the limit was $1 million and half that amount ($500,000) for a married taxpayer filing a separate return.
IRS Guidance On The New Restrictions
The IRS guidance on its website focuses initially on the interest deduction for home equity loans and lines of credit, which have been suspended under the TCJA, unless the loan proceeds are used to buy, build or substantially improve the taxpayer’s home that secures the loan.
The IRS then moves onto the mortgage interest deduction, offering these three examples:
Example 1: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000. In February 2018, the taxpayer takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total does not exceed the cost of the home. Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible. However, if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan would not be deductible.
Example 2: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $250,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages does not exceed $750,000, all of the interest paid on both mortgages is deductible. However, if the taxpayer took out a $250,000 home equity loan on the main home to purchase the vacation home, then the interest on the home equity loan would not be deductible.
Example 3: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $500,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. A percentage of the total interest paid is deductible (see Publication 936).
Foreign Currency Exchange Issues
Consideration should also be given to the tax consequences associated with currency exchange differences if your mortgage is denominated in a foreign currency.
These issues arise due to the fact that U.S. expats are required to use the U.S. dollar as their “functional currency” for monetary transactions.
Takeaway For U.S. Expatriates
For many expat taxpayers, the new larger standard deduction under the TCJA and other benefits such as the foreign earned income exclusionand foreign tax credits are sufficient to eliminate or significantly reduce their U.S. tax liability. For some, however, itemizing deductions, such as the home mortgage interest deduction, can play an important role in reducing the liability.
At Expat Tax Professionals, we continue to stay on top of the U.S. tax reforms that affect expat tax compliance. We will continue to provide you with the latest tax news affecting your expat tax filing obligations.
Have a question? Contact Ephraim Moss.
Your comments are always welcome!
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