Deductible interest and taxes under the Tax Cuts and Jobs Act

James DeRidder, BridgeTower Media Newswires

As most of us are well aware, the Tax Cuts and Jobs Act signed last December made many changes that affected both individuals and businesses. Now that the tax filing season is over for most of us, it’s a good time for a quick refresher on what changes were made for two of the biggest tax deductions taken by many taxpayers.

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Impact on homeowners

The impact on homeowners was the most widely publicized item. Traditionally, tax law provides numerous incentives for home ownership by allowing the deduction for mortgage interest and real estate tax. The Tax Cuts and Jobs Act (TCJA) modifies these popular tax benefits.

Mortgage interest. Home mortgage interest is generally deductible if it is paid or accrued on acquisition indebtedness or home equity indebtedness secured by any qualified residence (i.e., a principal or second residence). The deduction for acquisition indebtedness is limited to interest paid on the first $1 million of debt ($500,000 for a married taxpayer filing a separate return) and the first $100,000 on home equity loans ($50,000 for a married taxpayer filing a separate return).

Under the TCJA, a taxpayer may treat no more than $750,000 as acquisition indebtedness ($375,000 in the case of married taxpayers filing separately) for tax years beginning in 2018 through 2025.

Transition relief. A taxpayer who has entered into a binding written contract before Dec. 15, 2017, to close on the purchase of a principal residence before Jan. 1, 2018, and who purchases such residence before April 1, 2018, shall be considered to have incurred acquisition indebtedness prior to Dec. 15, 2017.

Additionally, the TCJA suspends the deduction for interest on home equity indebtedness. For tax years beginning in 2018 through 2025, you may not claim a deduction for interest on home equity indebtedness.

Real estate tax. Under the TCJA, for tax years beginning in 2018 through 2025, you may claim an itemized deduction of up to $10,000 ($5,000 for a married taxpayer filing a separate return) for the total amount of:

1. state and local property taxes not paid or accrued in carrying on a trade or business, and

2. state and local income (or sales taxes in lieu of income taxes) for the tax year.

Foreign real property taxes cannot be deducted under this exception.

Considering most readers are residents of New York, which is a high tax state, many of us will get little or no benefit for the real estate tax deduction since they will reach the $10,000 cap fairly quickly when adding them on top of the state income taxes.

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Impact on businesses

While the impact on individuals got the most publicity, businesses were also impacted by the Tax Cuts and Jobs Act when it comes to deducting interest expense. The IRS recently issued initial guidance on the limitation for deducting interest expenses related to a trade or business. The Tax Cuts and Jobs Act limits the deduction for business interest for any type of business starting in 2018 to a taxpayer’s interest income, plus 30 percent of adjusted taxable income. Any interest not deductible generally may be carried forward indefinitely to succeeding tax years.

Before 2018, only a C corporation’s deduction for business interest is limited for interest paid to related persons exempt from U.S. tax (i.e., the earnings stripping rule). The IRS will issue future regulations that will cover the carryover of disallowed interest deduction of a C corporation under the previous rule to 2018, as well as rules for affiliated groups and consolidated returns. Any disallowed and carried forward interest deduction will not affect whether or when such interest expense reduces earnings and profits.

For a partnership or S corporation, the post-2017 business interest deduction limit is generally applied at the entity level with respect to entity debt. However, the future regulations will prevent partners and S corporation shareholders from “double counting” interest income from the partnership or S corporation when calculating their own deduction limit.

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James DeRidder, CPA, is a principal in Mengel, Metzger Barr’s Tax Department. He may be reached at (585) 423-1860.

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