It’s Safe to Use Home Equity Loan

QUESTION: I seem to remember a ruling from the Internal Revenue Service several years ago having to do with using the money from a home equity loan for something other than home improvements. If my memory serves me right, the IRS wouldn’t allow the tax deduction. If that’s the case, aren’t a lot of us in for a big legal fight if we follow your advice and take out a home equity loan to get around the new tax reform law’s elimination of consumer interest deductions?--F. G. W.

ANSWER: Your concern is certainly a legitimate one--and one shared until recently by many tax advisers. But in the opinion of tax specialists, taxpayers are indeed free to use the money from home equity loans as they see fit--as long as they meet the requirement that the loan does not exceed the original purchase price of the home, less any existing loans on it, plus an allowance for home improvements.

(The borrowing ceiling, incidentally, is raised by the amount of any equity-based loan taken out to pay medical bills or to put children through college. Also, you are free to borrow any amount the lender will give you, of course. These restrictions only come into play for purposes of deducting the interest from your taxable income.)

The ruling you probably were thinking about, say researchers at the Research Institute of America, was handed down by the IRS in 1982. The case concerned a taxpayer who bought stocks and bonds with money from a home equity loan and, figuring that the expenses were consumer interest charges, took a full tax writeoff. The IRS objected. Interest on a second mortgage loan, the agency argued, is subject to limits on investment interest deductions when the proceeds are used to buy investment securities.

Tax specialists say that after reading the new tax reform law, they have no doubt that the 1982 ruling is now off the books and that consumers are entitled to use the proceeds from these types of loans however they please, without risking a lost tax deduction.

As you intimate, the proceeds from many of these loans are likely under tax reform to go toward such things as the purchase of a car or school tuition. Tax reform eliminates tax deductions for consumer interest from 1991 on, after a four-year phase-out.

Q: My car broke down last month and, while it was in the shop being repaired, I rented a replacement to go back and forth to work. I think that qualifies as a casualty, but I can’t get a straight answer from the IRS on whether I’m right.--S. E.

A: The IRS says you would have a hard time making your case, and several tax advisers agree with that assessment. To make a case for a casualty deduction, you generally must argue that the expense was caused by an accident or an act of God.

Q: I am a supervisor at a computer sales company. To keep morale up and productivity high, I often throw small office parties and arrange outings such as fishing or hunting trips or nights out at the bowling alley. The company always reimbursed me in the past but is going through a hard time now and has decided not to pay for such expenses any more. I really think they make our business better, though, so I hate to give them up. Is this something I can claim as a business expense and write off on my income tax return?--P. O.

A: It isn’t likely. In a case similar to yours, both the IRS and the Tax Court decided not to allow a deduction because the taxpayer couldn’t prove that the expenses were “ordinary and necessary to the business.”