Editor’s Note: This article was originally published on December 22, 2017.
If you’re used to claiming itemized deductions, tax reform may have a surprise in store for you and how you file your taxes in 2018. To get you up-to-date and help you understand how you might be affected, we provide a brief overview of itemized deductions and what has changed with tax reform, also known as the Tax Cuts and Jobs Act (TCJA).
The ability to Itemize deductions allows taxpayers to reduce their taxable income by claiming a variety of deductions instead of the standard deduction. These include mortgage interest, state and local income or sales taxes, property taxes on their homes and cars, charitable contributions, and more. Traditionally, about 30% of taxpayers have itemized deductions (on Schedule A) because their total itemized deductions were more than the standard deduction, based on their filing status.
However, the 2017 tax reform eliminated or restricted many itemized deductions beginning in 2018 and raised the standard deduction. That means fewer taxpayers are likely to itemize.
Itemized Deduction Phase Out Elimination and Major Changes
Prior to tax reform, taxpayers were subject to an itemized deduction phase out or limit (often called the Pease limit), which applied to certain deductions including those for home mortgage interest, state and local taxes, and charitable contributions. Starting in 2018, this limit has been eliminated. Here’s how the TCJA changes to itemized deductions have altered the tax landscape.
Capping the State and Local Tax Deduction: Less SALT
Your doctor may have recommended a restricted salt diet, and so has Congress: Under the TCJA, the deduction for all state and local taxes combined cannot exceed $10,000. These taxes include state and local income or sales taxes, real estate taxes, and personal property taxes. Taxpayers in high-tax states may see much of their SALT deduction reduced, and limiting this one deduction could mean itemizing won’t make sense for many taxpayers. The impact of the new limit on any one taxpayer depends on their specific situation.
Mortgage and Home Equity Loan Interest
The cost of buying or owning a home has traditionally been made more affordable by the deductibility of mortgage interest and real estate taxes. Although real estate taxes are included in the $10,000 limit for all state and local taxes, mortgage interest remains deductible – with two important changes.
First, for mortgages taken out after December 14, 2017, only the interest on the first $750,000 of mortgage debt is deductible. This may not be a factor where housing prices are relatively low and mortgages are below this limit. However, a mortgage this size is common in locations with high residential real estate costs. For example, the median home price in San Francisco is $1.5 million.
Also, interest on home equity loans will no longer be deductible after 2017. This affects interest on all home equity loans used for purposes other than to improve the current home, even if the loan was taken out before December 15, 2017.
So, if you take out a mortgage of less than $750,000 after December 14, 2017, or if your mortgage is more than $750,000, but you took it out before that date, you won’t lose any of your interest deduction. Of course, if for other reasons you can’t itemize, your otherwise deductible mortgage interest will have no effect on reducing your federal tax.
Charitable Contributions Survive – and Thrive
The TCJA enhanced the deduction for charitable contributions by raising the limit that can be contributed in any one year. The limit is now 60% of adjusted gross income, up from 50%.
For the 2015 tax year, 82% of taxpayers who itemized claimed a charitable contribution. So, if you can still itemize, you can continue to deduct charitable contributions, but doing so only reduces your taxes if all your itemized deductions exceed the newly raised standard deduction.
Some taxpayers who have lost the value of some deductions (such as the state and local tax deduction) may make up the difference by contributing more to their favorite charity so they can continue to claim itemized deductions after tax reform.
Other Itemized Deductions
The medical expense deduction also has been changed under the TCJA. Under prior law, taxpayers whose unreimbursed medical expenses exceeded 10% of their adjusted gross income (AGI) could deduct that excess. Under the TCJA, taxpayers may deduct unreimbursed medical expenses that exceed 7.5% of their AGI. This change has been made retroactive to January 1, 2017, and is effective for the 2017 and 2018 tax years.
SALT, mortgage interest, and charitable contributions are among the most widely claimed deductions, but the list of itemized deductions allowable before 2018 was more extensive. Gone in 2018 are itemized deductions for unreimbursed employee expenses, tax preparation fees and other miscellaneous deductions. Also gone is the deduction for theft and personal casualty losses, although certain casualty losses in federally declared disaster areas may still be claimed.
For taxpayers who used to claim itemized deductions, it may no longer make sense after tax reform if the new higher standard deduction exceeds what their itemized deductions would have been.
For example, suppose in 2017 a taxpayer who files as Single had itemized deductions of $9,200, or $2,850 more than the standard deduction of $6,350. Suppose in 2018 this taxpayer again has $9,200 in expenses that would have been deductible in 2017. With a new, higher standard deduction of $12,000, the taxpayer can deduct $2,800 more using the standard deduction than by itemizing.
Changes to Itemized Deductions Aren’t the Only Tax Reform Updates to Consider
Itemizing versus claiming the standard deduction is only one comparison the taxpayer should make. Tax returns have many moving parts, and while this taxpayer benefits from a higher standard deduction, he will need to consider other aspects of his return. For example, personal exemptions are no longer allowed, which would have reduced his taxable income by over $4,100. This, in turn, may be offset by a lower tax rate.
Wondering If You’ll Continue to Claim Itemized Deductions After Tax Reform?
Each taxpayer’s situation may be slightly different. If you’re curious to find out how the new tax laws affect you, get an estimate from our tax return and tax reform calculator and make an appointment to visit with a tax professional. He or she will help you navigate the new tax laws.