Are Home Equity Loans Tax Deductible?
If you’ve taken out a home equity loan, or are thinking about it, you might be wondering if there’s any relief waiting for you when tax season rolls around. The short answer is? It depends.
The IRS has some specific rules about when you can deduct the interest on your loan, and they mostly boil down to how you use the money. Planning a big home improvement? You might qualify. Covering credit card debt? Not so much.
If flexibility is what you’re after, consider how a HELOC from Rate can give you access to funds when you need them while keeping your financial goals on track.
Is a Home Equity Loan Interest Tax Deductible?
In many cases, the answer is yes, but only if you meet specific criteria set by the Internal Revenue Service (IRS). Changes introduced by the Tax Cuts and Jobs Act (TCJA) in December 2017 tightened the rules, making it more challenging to claim deductions for home equity loan interest.
To qualify, the funds from your home equity loan must be used exclusively for buying, building, or making substantial improvements to your primary residence or a second home.
For example, if you used the loan to remodel your kitchen, install energy-efficient windows, or add a new bedroom, the interest on the loan might be deductible.
However, if the funds were used for personal expenses, like paying off credit card balances or covering medical bills, the interest won’t qualify for a tax deduction. This distinction is critical because the IRS no longer allows deductions for home equity debt used for anything other than home-related purposes.
What Are the Rules for Deducting Interest on a Home Equity Loan or HELOC?
To claim a deduction for interest on a home equity loan or home equity line of credit (HELOC), certain rules must be followed. The IRS has outlined these requirements to make sure taxpayers use the funds appropriately:
Your Loan Must Be Backed by Your Home
The property, whether it’s your main home or a second home, must serve as collateral for the loan. Without this, the interest doesn’t qualify under current tax law.
The Funds Must Be Used for Qualified Purposes
These purposes include buying, building, or making substantial improvements to the taxpayer’s residence. For instance, using the loan to build an addition, replace the roof, or enhance the home’s value through other renovations aligns with IRS guidelines.
Your Total Mortgage Debt Must Fall Within IRS Limits
If your combined mortgage debt, including your first mortgage, second mortgage, or any home equity debt, exceeds $750,000 for joint filers ($375,000 for single filers), the interest on the portion of the debt that surpasses the limit cannot be deducted.
For mortgages taken out before December 15, 2017, the prior limit of $1 million ($500,000 for single filers) may still apply, depending on the specific circumstances of the loan.
By meeting these rules, homeowners may qualify for deductions that reduce their taxable income. However, it’s important to document how the funds were used because the IRS may require proof during tax time.
Keeping records of your renovation expenses like receipts or contracts can help prove your claims.
How to Deduct Home Equity Loan Interest
Wondering if you can deduct the interest paid on your home equity loan? Follow these steps to see if you may qualify for this valuable tax benefit:
Confirm Your Interest Is Eligible
The IRS is clear about how borrowed funds from a home equity loan can be used to qualify for a tax deduction. To be eligible, the loan must have been spent on improvements to the taxpayer’s main home or second home.
Examples of qualifying improvements could include a kitchen remodel, adding a new roof, or building a home addition. Funds used for personal expenses like a vacation, medical bills, or paying off a credit card, do not qualify.
If you're unsure whether your expenses meet the criteria, consulting a financial advisor can help clarify your eligibility.
Gather Your Mortgage Statements and Required Documents
Documentation is key to claiming the deduction. Keep detailed records showing how the borrowed funds were used. This includes receipts, invoices, and contracts related to home improvement projects.
You’ll also need your mortgage interest statement (Form 1098) from your lender, which shows the amount of interest paid on your mortgage loan during the tax year. These records can help you prove your claim if the IRS requires additional information.
List and Calculate Your Tax Deductions
Using Form 1098, determine the total amount of home equity loan interest you paid over the year. Include only the portion of interest that meets IRS criteria for deductibility.
For example, if part of the loan was used for home improvements and another part for personal expenses, only the qualifying portion can be deducted.
Include Your Mortgage Points in the Calculation
Discount points paid to secure a lower interest rate on your home equity loan may also be deductible. These points, which are essentially prepaid interest, can be a valuable tax benefit.
Check your loan documents or ask your lender for the exact amount you paid in points, as this can further reduce your taxable income.
Decide Between a Standard Deduction or Itemizing
The decision to itemize or take the standard deduction depends on your overall financial situation.
If your total itemized deductions like, mortgage interest, local property taxes, and medical expenses, exceed the standard deduction for your filing status, itemizing could save you more on your income taxes.
If not, the standard deduction might be the better choice. A financial advisor can help weigh the pros and cons based on your specific circumstances.
Are HELOCs Also Tax-Deductible?
Yes, but the same IRS rules apply. The tax deductibility of HELOC interest depends entirely on how you use the borrowed funds.
If the loans are used for large improvements to your taxpayer’s main home or second home, the interest qualifies for a deduction. Examples include a renovation project like upgrading your kitchen or replacing windows to improve energy efficiency.
However, if the line of credit is used for personal expenses, such as paying off a credit card loan or funding non-property-related costs, the interest won’t be deductible. This is an important distinction to keep in mind, especially as tax laws have become more restrictive under the Tax Cuts and Jobs Act.
HELOCs are popular for their flexibility, as they allow you to borrow only what you need when you need it, often at lower interest rates than credit cards. Just remember to keep tabs on your spending.
The IRS may request proof of how the loan proceeds were used, so keep records like receipts, invoices, and bank statements is essential. A financial advisor or tax professional can help you navigate the process and maximize your tax benefits.
How Do I Report a Home Equity Loan on My Taxes?
To report a home equity loan, include your mortgage interest on Schedule A of your federal income tax return. Use Form 1098 from your lender to calculate the total interest paid during the tax year. If the loan was used for a renovation project or home repairs, ensure you have proper records to back up your claim in case the IRS requests proof.
Pros and Cons of Home Equity Loans
Pros
Lower Interest Rates Compared to Other Borrowing Options
Home equity loans generally offer lower interest rates than personal loans or credit cards because they are secured by your home. This makes them a cost-effective way to finance major expenses.
Fixed Interest Rates for Predictable Monthly Payments
Most home equity loans come with a fixed interest rate. This means your monthly payments stay the same, making it easier to budget and plan ahead.
Access to a Lump Sum of Cash
With a home equity loan, you receive the full loan amount upfront, making it a solid choice for large expenses like home renovations, medical bills, or debt consolidation.
Potential Tax Deductibility
If you use the funds to improve your home—like remodeling your kitchen, replacing your roof, or upgrading your HVAC system, you may be able to deduct the interest paid on your loan. Always check IRS guidelines or consult a tax professional to confirm you are eligible.
Longer Repayment Terms Keep Monthly Payments Manageable
Home equity loans typically come with repayment terms of 10 to 30 years, allowing you to spread out payments over time and keep them affordable.
Cons
Your Home Secures the Loan, Meaning Foreclosure Is a Risk
Since your home is collateral for the loan, falling behind on payments could put you at risk of foreclosure. It’s important to make sure you can handle the monthly payments before borrowing.
Closing Costs and Fees Can Add Up
Like a first mortgage, home equity loans often come with upfront costs, including closing fees, appraisal fees, and lender charges. These expenses can range from 2% to 5% of the loan amount.
Could Reduce Your Home Equity and Financial Flexibility
Borrowing against your home reduces the equity you’ve built, which could limit your ability to refinance or sell your home in the future. If home values drop, you could end up owing more than your home is worth.
Not the Best Option for Short-Term Borrowing Needs
Because home equity loans are long-term commitments, they aren’t ideal for short-term financial needs. If you need quick access to smaller amounts of cash over time, a HELOC might be a better fit.
How to Get a HELOC
A HELOC can be a flexible way to access the value of your home for home improvement projects, a second home, or other financial goals. The key is using the funds wisely to maximize benefits, including potential tax deductions.
If you’re ready to explore how a HELOC can work for you, check out Rate’s HELOC options. With competitive rates, manageable monthly payments, and expert guidance, it’s an easy way to put your home’s equity to work.
Rate, Inc. does not provide tax advice. The consumer should always consult a tax advisor for information regarding the deductibility of interest and other charges in their particular situation.
Not all products discussed are available from Rate. Talk to a loan officer for more information about loan options.