Itemized Deduction and Expense Information

The Most-Important Affected Expenses

The list of now-disallowed expenses is long. But the ones that are most likely to adversely affect you are these three.

Unreimbursed Employee Business Expenses. Lots of folks pay relatively large amounts out of their own pockets to go back to school to improve their resumes. If the education maintains or improves skills used in your current job or profession, you could claim the cost as an unreimbursed employee business expense under prior law. For example, the cost to obtain an MBA degree would often qualify. Another common unreimbursed employee business expense is the cost of using your own car for business-related travel. Since you can’t deduct that expense anymore, try negotiating with your employer to cover it through tax-free reimbursements under an accountable plan.
Tax and Investment Related Expenses. These too are incurred by many folks and could have been significant enough to get you over the prior-law 2%-of-AGI deduction threshold when combined with other miscellaneous itemized expenses.
Hobby-Related Expenses. Under prior-law you could treat hobby-related expenses up to the amount of income from the hobby as a miscellaneous itemized deduction. These expenses were often big enough to clear the 2%-of-AGI deduction threshold when combined with other miscellaneous itemized expenses. Under the TCJA, as under prior law, you still have to report 100% of hobby income on your return. But for 2018-2025, you can no longer deduct any of your hobby-related expenses.

Information from the IRS regarding Schedule A (Form 1040 or 1040-SR), Itemized Deductions

You Can Still Deduct Some Miscellaneous Expenses

Certain other miscellaneous itemized expenses were not subject to the 2%-of-AGI deduction threshold under prior law. On the 2019 Form 1040, those expenses are reported on Line 16 of Schedule A. The TCJA did not suspend itemized deductions for these expenses, and they are still not subject to the 2%of-AGI deduction threshold. They include gambling losses to the extent of gambling winnings, amortizable bond premiums, federal estate tax on income in respect of a decedent, impairment-related work expenses, and repayments of more than $3,000 under a claim of right.

TCJA’s Continuing lmpact on Miscellaneous Itemized Deductions

For 2018-2025, the TCJA suspends write-offs for miscellaneous itemized deduction items that under prior law were subject to the 2%-of-AGI deduction threshold [IRC Sec. 67(g)].

Eliminated Tax-Related Expenses

Tax preparation expenses
Tax advice fees
Other fees and expenses incurred in connection with the determination, collection, or refund of any tax

Expenses Related to Taxable Investments and Production of Taxable Income

Investment advisory fees and expenses
Clerical help and office rent for office used to manage investments
Expenses for home office used to manage investments
Depreciation of computer and electronics used to manage investments
Fees to collect interest and dividends
Your share of investment expenses passed through to you from partnership, LLC, or S corporation
Safe deposit box rental fee for box used to store investment items and documents
Other investment-related fees and expenses
Hobby expenses (limited to hobby income)
IRA trustee/custodian fees if separately billed to you and paid by you as the account owner
Loss on liquidation of traditional IRAs or Roth IRAs
Bad debt loss for soured loan made to employer to preserve your job
Damages paid to former employer for breach of employment contract
Unreimbursed Employee Business Expenses
Education expenses related to your work as an employee
Travel expenses related to your work as an employee
Passport fees for business trip
Professional society dues
Professional license fees
Subscriptions to professional journals and trade publications
Home office used regularly and exclusively in your work as an employee and for the convenience of your employer
Depreciation of computer that your employer requires you to use
Tools and supplies used in your work as an employee
Union dues and expenses
Work clothes and uniforms if required for your work and if not suitable for everyday use
Legal fees related to your work as an employee
Job search expenses to seek new employment in your current profession or occupation

Limited Deductions for State and Local Taxes

For 2018-2025, the TCJA limits itemized deductions for personal state and local income and property taxes to a combined total of $10,000 ($5,000, if MFS). For 2018-2025, foreign real property taxes cannot be deducted at all. However, you can still opt to deduct state and local general sales taxes instead of state and local income taxes, subject to the $10,000/$5,000 limitation.

TCJA Limitation-Deducting State and Local Taxes Continues

For 2018-2025, the Tax Cuts and Jobs Act (TCJA) trimmed two important tax breaks for homeowners and left another big one completely untouched. Here’s the story, in three segments starting with this one.

Limit on Deductions for State and Local Taxes, Including Real Property Taxes

Under prior law (before the TCJA), you could claim itemized deductions for an unlimited amount of personal (non-business) state and local property and income taxes on Schedule A of Form 1040. If you had a big property tax bill, you could deduct the whole thing if you itemized. Individuals with big personal state and local income tax bills could fully deduct those too on Schedule A, if they itemized.

Finally, you had the option of deducting personal state and local general sales taxes on Schedule A instead of state and local income taxes (beneficial if you owe little or nothing for state and local income taxes). For 2018-2025, the TCJA changes the deal by limiting itemized deductions for personal state and local property taxes and personal state and local income taxes (or sales taxes if you choose that option) to a combined total of only $10,000 ($5,000 if you use married filing separate status). For 2018-2025, personal foreign real property taxes cannot be deducted at all. So, no more deductions for property taxes on that place in Cabo. [See IRC Sec. 164(b)(6).]

This TCJA change unfavorably affects individuals who pay high property taxes because they live in a high-property-tax jurisdiction, own an expensive home (resulting in a hefty property tax bill), or own a primary residence and one or more vacation homes (resulting in a bigger property tax bill due to owning several properties). Individuals in these categories can now deduct a maximum $10,000 (or $5,000) of personal state and local property taxes-even if they deduct absolutely nothing for personal state and local income taxes or general sales taxes.

Tax Planning Considerations

First, none of the preceding information matters unless you have enough itemized deductions to exceed the allowable standard deduction. That will be the case for fewer folks than under prior law, because the TCJA almost doubled the standard deduction amounts. The 2020 standard deduction for married joint filing couples is $24,800 (compared to $12,700 for 2017). The 2020 standard deduction for heads of households is $18,650 (versus $9,350 for 2017). The 2020 standard deduction for singles and those who use married filing separate status is $12,400 (versus $6,350 for 2017).

Second, there is not much opportunity for gamesmanship with deductions for real property taxes. The only way you could potentially deduct more than $10,000 (or $5,000 if you use married filing separate status) is if you own a home that is used partially for business (for example, because you have a deductible office in the home) or partially rented out (for example the basement of your main residence or a vacation home during part of the year). In those situations, you could deduct property taxes allocable to those business or rental uses on top of the $10,000 limit-subject to the rules that apply to deductions allocable to those uses. For example, home office deductions cannot exceed the income from the related business activity, and deductions for the rental use of a property that is also used as a personal residence generally cannot exceed the rental income.

If you pay both state and local property taxes and state and local income taxes (or sales taxes if you choose that option), trying to increase your property tax deduction may reduce what you can deduct for state and local income taxes. For example, if you have $8,000 of state and local property taxes and $10,000 of state and local income taxes, you can deduct the full $8,000 of property taxes but only $2,000 of income taxes. If you want to deduct more income tax, your property tax deduction goes down dollar-for-dollar.

Warning: If you are in the AMT mode, itemized deductions for personal state and local property taxes are still completely disallowed under the AMT rules. Ditto for personal state and local income taxes (or sales taxes if you choose that option). This AMT disallowance rule was in effect before the TCJA, and it still applies in the post-TCJA world.

Conclusion: None of this state and local tax deduction stuff matters unless you have enough itemized deductions to exceed the allowable standard deduction. That will be the case for fewer taxpayers than under prior law, because the TCJA almost doubled the standard deductions for 2018-2015.

TCJA Limitations on Mortgage Interest Deductions Continue to Impact Homeowners

For 2018-2025, the Tax Cuts and Jobs Act (TCJA) shifts the playing field for home mortgage interest deductions. Many homeowners will be unaffected because favorable grandfather provisions will keep the prior-law rules in place for them. However, many homeowners will be adversely affected by the TCJA provision that generally disallows interest deductions for home equity loans for 2018-2025. This analysis explains what you need to know about how the TCJA continues to affect home mortgage interest deductions.

Prior Law (The “”Good Old Days” for Deducting Home Mortgage Interest)

Before the TCJA, you could deduct interest on up to $1 million of home acquisition indebtedness (incurred to buy or improve a first or second residence) or up to $500,000 for those who used married filing separate status. Before the TCJA, you could also deduct the interest on another $100,000 of mortgage debt if the loan proceeds were used to buy or improve a first or second residence, or $50,000 for those who used married filing separate status. [See IRC Sec. 163(h)(3)(A), (B), and (C) and Rev. Rul. 2010-25.] The additional $100,000/$50,000 could be in the form of a bigger first mortgage or a home equity loan. Either way, the additional $100,000/$50,000 was characterized as home equity debt the proceeds of which were spent to buy or improve a first or second residence (Rev. Rul. 2010-25). So the debt limit for deductible interest under prior law was really $1.1 million, or $550,000 for those who used married filing separate status. The TCJA cuts those numbers back significantly.

Under prior law, you could also deduct interest on up to $100,000 of home equity indebtedness for regular tax purposes, regardless of how you used the loan proceeds. [See IRC Sec. 163(H)(3)(C).] (For AMT purposes, however you could only deduct the interest if the loan proceeds were used to buy or improve a first or second residence.)

TCJA Alters the Playing Field for 2018-2025

Now for the bad news, which as we said earlier, will have no impact on many homeowners.

TCJA Change for Home Acquisition Indebtedness. For 2018-2025, the TCJA generally allows you treat interest on up to $750,000 of home acquisition indebtedness (incurred to buy or improve a first or second residence) as deductible qualified residence interest. For those who use married filing separate status, the debt limit is halved to $375,000. (See IRC Sec. 163(h)(3)(F)(i)(II).] Thanks to a grandfather provision for pre-TCJA mortgages (explained below), this change will mainly affect new buyers who take out large mortgages to buy places in high-cost areas.

TCJA Change for Home Equity Indebtedness. For 2018-2025, the TCJA generally eliminates the prior-law provision that allowed interest deductions for up to $100,000 of home equity indebtedness, or $50,000 for those who use married filing separate status, to be treated as deductible qualified residence interest. (See IRC Sec. 163(h)(3)(F)(i)(I).] This general elimination of deductions for interest on home equity loans will affect more homeowners than the new limits on home acquisition indebtedness.

Grandfather Rules for Up to $1 Million of Home Acquisition Indebtedness. Under one grandfather rule, the TCJA changes do not affect interest deductions on up to $1 million of home acquisition indebtedness that was taken out: (1) before 12/16/17, or (2) under a binding contract that was in effect before 12/16/17, as long as the home purchase closed before 4/1/18.

Under a second grandfather rule, the TCJA changes do not affect interest deductions on up to $1 million of home acquisition indebtedness that was taken out before 12/16/17 and then refinanced later-to the extent the initial principal balance of the new loan does not exceed the principal balance of the old loan at the time of the refinancing.

Home mortgage interest that is deductible under either the prior-law rules or the TCJA rules is termed qualified residence interest.

Non-Itemizers Can Ignore TCJA Changes. These changes don’t matter if your client does not have enough itemized deductions (including deductions for qualified residence interest) to exceed the applicable standard deduction under the new law. Many taxpayers more will now fall into that category, because the TCJA almost doubles the standard deductions for 2018-2025.

Others Can Ignore TCJA Changes Too. These changes also don’t matter if your client has a relatively modest amount of home acquisition indebtedness and no home equity indebtedness. That will be the case for many people. Even many homeowners with relatively large amounts of home acquisition indebtedness will be unaffected by the TCJA changes, because their mortgages will fall under the favorable grandfather rules.

For 2026 and beyond, the more-generous prior-law rules for home acquisition indebtedness and home equity indebtedness are scheduled to return.

Examples Illustrate Impact of TCJA Changes

Here are some examples of how the new TCJA home mortgage interest deduction rules work in simple situations, including ones where the homeowner has taken out a home equity loan-which will usually be in the form of a home equity line of credit (HELOC).

Example 1 Big first mortgage. Billy and Betsy are a married joint-filing couple with a $1.5 million mortgage that was taken out to buy their principal residence in 2016. In 2017, the couple paid $60,000 of mortgage interest, and they could deduct $44,000 [($1.1 million/$1.5 million) x $60,000 = $44,000] as deductible qualified residence interest.

For 2018-2025, the grandfather rule allows Billy and Betsy to treat $1 million as home acquisition indebtedness. If they pay $55,000 of mortgage interest in 2018, 2019, and 2020, they can treat $36,667 annually [($1 million/$1.5 million) x $55,000 = $36,667] as deductible qualified residence interest.

For simplicity, we assume the loan balance is $1.5 million in 2017-2020.

Example 2

Big first mortgage is refinanced after the TCJA. Same basic facts as in Example 1, except this time assume that Billy and Betsy refinanced their mortgage on 7/1/20, when it had a balance of $1.35 million, by taking out a new mortgage for $1.35 million.

Under the grandfather rule for up to $1 million of refinanced home acquisition indebtedness, the couple can treat the interest on $1 million of the new mortgage as deductible qualified residence interest for 2020-2025.

Example 3

Homeowner has pre-TCJA HELOC.

Santiago is an unmarried individual with an $800,000 first mortgage that he took out to buy his principal residence in 2012. In 2017, he opened a HELOC and borrowed $80,000 to pay off his car loan, credit card balances, and various other personal debts.

On his 2017 return, Santiago can deduct all the interest on the first mortgage as deductible qualified residence interest under the rules for home acquisition indebtedness. For regular tax purposes, he can also treat all the HELOC interest as deductible qualified residence interest under the rules for home equity indebtedness (but the interest is disallowed under the AMT rules because the HELOC proceeds were not used to buy or improve a first or second residence).

For 2018-2025, Santiago can continue to treat all the interest on the first mortgage as deductible qualified residence interest under the grandfather rule for up to $1 million of home acquisition indebtedness. But he cannot treat any of the HELOC interest as deductible qualified residence interest.

Example 4

Another HELOC scenario.

Same basic facts as in Example 3, except this time assume that Santiago used the $80,000 from the HELOC to remodel the first floor of his principal residence. On his 2017 return, he can deduct all the interest on the first mortgage and the HELOC, because he can treat the combined balance of the loans as home acquisition indebtedness that does not exceed $1.1 million.

For 2018-2025, Santiago can continue to treat the interest on both loans as deductible qualified residence interest under the grandfather rule for up to $1 million of home acquisition indebtedness.

Example 5

HELOC scenario with suboptimal tax results (apparently).

Alexandra is an unmarried individual with an $800,000 first mortgage that was taken out in July of 2017 to buy her principal residence. In 2018, she opens a HELOC and borrows $80,000 to remodel her kitchen and bathrooms.

For 2018-2025, Alexandra can treat all the interest on the first mortgage as deductible qualified residence interest under the grandfather rule for up to $1 million of home acquisition indebtedness. However, because the $80,000 HELOC was taken out in 2018, the TCJA $750,000 limit on home acquisition indebtedness apparently precludes any deduction for the HELOC interest. That is because the entire $750,000 post-TCJA limit on home acquisition indebtedness was absorbed (and then some) by the grandfathered $800,000 first mortgage. The HELOC balance apparently cannot be treated as home acquisition debt, even though the loan proceeds were used to improve Alexandra’s principal residence. Instead the HELOC apparently must be treated as home equity debt, and interest on home equity debt cannot be deducted as qualified residence interest for 2018-2025.

Example 6

HELOC scenario with better tax results.

Same basic facts as in Example 5, except this time assume that the first mortgage taken out by Alexandra was for only $650,000.

For 2018-2025, she can treat all the interest on the first mortgage as deductible qualified residence interest under the grandfather rule for up to $1 million of home acquisition indebtedness. The $80,000 HELOC balance also can be treated as home acquisition indebtedness, because the combined balance of the first mortgage and the HELOC is only $730,000, which is under the post-TCJA limit of $750,000 for home acquisition indebtedness. Alexandra can treat all the interest on both loans as deductible qualified residence interest for 2018-2025.

Note In Information Release IR-2018-32, the IRS provided some examples to explain when home equity loans can be treated as home acquisition indebtedness.

Tax Planning Considerations

Interest-only mortgages look more attractive in the post-TCJA world, if all the interest can be deducted under the grandfather rule for refinanced home acquisition indebtedness. For example, if you refinance $1 million of pre-TCJA home acquisition indebtedness with a new $1 million interest-only loan, you can continue to deduct all the interest under the grandfather rule for refinanced home acquisition indebtedness of up to $1 million. In contrast, if you gradually pay down your $1 million of pre-TCJA home acquisition indebtedness by making principal payments in 2018-2025, you won’t be able to treat any part of an additional home loan taken in 2018-2025 as home acquisition indebtedness-because your existing loan will absorb the entire $750,000 TCJA limit.

The same concept discourages making bigger-than-required principal payments in 2018-2025 on grandfathered home acquisition indebtedness that exceeds $750,000.

Conclusion

The new TCJA limits on deducting home mortgage interest will probably not affect as many homeowners as the new limit on state and local tax deductions, but clients with larger mortgages and home equity loans must take heed.

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