What are the Changes in Mortgage Interest Deductions?
The new tax laws made three major changes in the deduction of interest paid on a home. First, the rules on home equity loan debt and interest changed. The definitions of acquisition debt (AD) and home equity debt (HED) did not change. HED is any debt secured by the taxpayer’s residence where the proceeds were not used to buy, build or improve that residence. Interest paid on HED is no longer deductible.

Second, AD is now limited to $750,000. Interest paid on debt secured by the taxpayer’s principal residence or secondary residence is only a deduction for the first $750,000 in principal balance.
Third, AD must be secured by the residence on which the proceeds were used. Loan proceeds that were not used to buy, build or improve the residence securing the loan must be subtracted from the principal and classified as HED. HED interest is not deductible.

Many mortgages are a mix of AD and HED often caused by refinancing. The IRS is very serious about tracing rules used to determine the deductible interest in mixed loans. HED, since interest is not deductible, is the least tax beneficial. Under the tracing rules, the principal portion of the mortgage payment is first applied to the HED portion of a mixed loan.  The ratio of AD and HED principal balances is then multiplied by the total mortgage interest payment to obtain the deductible AD interest and the non-deductible HED interest. Note that the AD portion remains the same until the entire HED principal is paid since no principal payments apply to the AD until there is no more HED.

Finally, there is no grandfathering. In audit, the IRS will require the entire history of financing of the property(s) to determine the AD and HED balances. The tracing rules apply to each year even though in years before 2018 both AD and HED interest was deductible.

Changes to Home Loans and Equity Loans
TCJA reduced the deduction for some home loans and completely eliminated deduction of interest on equity loans. These changes will impact many taxpayers.

Taxpayers who use funds from loans secured by a home must be able to trace the funds to home improvement and other uses then reduce the deduction shown on the forms 1098 from their lender by the appropriate ratio. The taxpayer must retain substantiation of the trace of each dollar to its final use for the life of the loan because while the loan may have been taken out years past the statute of limitations, interest is current.

A taxpayer may choose to treat any debt secured by a qualified residence as not secured by the home.  This is known as a “10T” election. This election applies to the entire secured debt as opposed to the allocation tracing approach. The reason for such an election is that interest on a debt secured by a home is classed as Qualified Home Equity Interest subject to limits that apply to same. The 10T election establishes a different classification to which the limits may be different.

A common use of home equity is the purchase of a second home, a “cabin in the mountains,” for recreation or a future retirement home. Before the recent tax act, interest paid on a home equity loan was deductible. No longer. Loans against the equity in a qualified residence can only be used for improvements on that same residence, not for purchase or improvement of any other property. To gain deductible interest, the loan must be secured by that second property, not by the principal residence.

By the way, you cannot add that interest to the basis of the second property either.

New California Law Defining Independent Contractors
Law inspired by a California Supreme Court decision placing Uber and Lyft drivers under labor
laws now defines what workers can be classed as independent contractors. It is called the ABC
test.

A- the worker cannot be under the direct supervision or guidance of the hiring entity. This is
unchanged from prior law.
B- the work cannot be within the scope of the usual business of the hiring entity. This is the
major change. See below for an example.
C - the worker must customarily perform the same or similar work for others. This is also
unchanged from prior law.

Example of where criteria B comes into play. Let us say that you hire someone to flip an
advertising sign directing people to your business or to a special sale. Is this within the scope of
your usual business? Advertising is certainly within the scope of your business, so does that force
you to make this person an employee with labor law benefits, registration and taxation as an
employee? He would also fail the C test, so probably EDD would say he was an employee.
This new law would almost eliminate independent contractor classification. How do you work
around this? Anyone who satisfies the C test is in business to perform the work and is a vendor
or subcontractor. You can hire subcontractors to do work directly related to your usual business
as a common practice, especially in the GIG economy. A properly worded contract would take
care of any needed guidance on guidance for A. Simply do not call them an independent
contractor and make sure you have a signed contract.