Is HELOC or Home Equity Loan Interest Tax Deductible?
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Summary:
Technically, home equity loan or HELOC interest is tax deductible as long as you use the money on significant home improvements. However, because of the Tax Cuts and Jobs Act of 2017, certain modifications have been made that affect tax deductions on the interest paid on home equity loans and home equity lines of credit.
If you want to make some home improvements or pay off credit card debt and have equity in your home, a home equity loan or a home equity line of credit (HELOC) is a great way to access those funds. However, the rules on whether you can take the mortgage interest deduction for home equity loans on your tax return are more complex.
Today we’ll take a closer look at when you can deduct interest paid on home equity loans and HELOCs and situations where you can’t. We’ll also discuss further IRS requirements for taking a HELOC or home equity loan interest tax deduction, which years it applies to, and what you need to provide to the IRS to qualify for the tax break.
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Is home equity loan or HELOC interest tax deductible?
As a result of modifications made by the Tax Cuts and Jobs Act, homeowners cannot take a tax deduction for interest paid toward home equity debt from the tax years 2018 through 2025, with one exception.
According to the Internal Revenue Service (IRS), however, “Interest paid on home equity loans and lines of credit in tax years before 2018 and tax years after 2025 is only deductible when you use the proceeds to buy, build or substantially improve your home that secures the loan.” This could also mean a secondary home, which is considered a qualified residence.
So, to be able to take home equity tax deductions, you must meet both of the following criteria:
- The home equity loan or HELOC needs to be secured by your primary residence (or a secondary residence).
- The loan funds must be used to “buy, build, or substantially improve” the home (or homes) in which the loan is secured against.
For example, if you use the entire loan proceeds to renovate the attic into a home office, or replace the windows and siding, you can probably deduct all of the interest you’ve paid. On the other hand, if you’ve used some for home renovations and some for personal use, such as debt consolidation, you could only take an interest deduction on the portion used for home improvements.
Pro Tip
The chances of being audited by the IRS are pretty slim. But just in case, you should keep all receipts and records of any home improvements you make in case one day the IRS does come knocking.
Does a home equity loan count as taxable income?
One of the nice things about getting a lump sum of cash from a home equity loan is that it’s not considered income or capital gains, so you’re not taxed on it as such. The downside is that there is no home equity loan interest deduction unless you use the money to make substantial improvements to the property.
To get a better idea of how much a home equity loan may provide you, take a look at some of the lenders below.
Home mortgage interest deduction guidelines
You can only deduct home mortgage interest on the first $750,000 owed, or $375,000 if married filing separately. However, higher limitations do apply if you are deducting mortgage interest from debt incurred before December 16, 2017. In that case, it would be $1 million for most people, or $500,000 if married filing separately.
IMPORTANT! These limits apply to your total mortgage debt, which includes any home equity loan or home equity line of credit on top of your primary mortgage. So if your total mortgage debt is $1.5 million, at this time, you could only deduct mortgage interest from half of that.
Itemized deductions vs. standard deduction
It’s important to know that taxpayers have two options for deductions when filing their tax returns. You can either take the standard deduction, which reduces your taxable income by a set amount (which increases each year), or you can itemize your deductions.
Itemizing your deductions means (no surprises here) listing each deduction individually, and this is the only way to get a tax break from the interest you paid on your combined mortgage debt. If you’re in doubt about which tax deductions you can take, you might want to speak to a tax advisor, but the following are some examples.
- Property taxes
- Mortgage points (if applicable)
- Real estate tax
- Sales tax
- Medical expenses not covered by insurance
- Other state and local taxes
- Charitable contributions
- Gambling losses
- Miscellaneous expenses
Itemized deductions are helpful if your total deductions will equal more than the standard deduction. The vast majority of Americans use the standard deduction because it’s usually more than they could deduct if they itemize. It’s also a lot less time-consuming when you don’t have to keep track of so many expenses.
Pro Tip
Tax issues are complex and can be difficult to figure out on your own. Because of this, sometimes it’s worth checking in with a tax professional before filing your taxes. However, you can also use online tax preparation programs to help you through the steps.
Who else benefits from itemizing deductions?
Being able to deduct the interest from mortgage debt is just one of the reasons why individuals might want to itemize their deductions. For example, you might also benefit if you:
- Can’t use the standard deduction or the amount you can claim is limited
- Had large unreimbursed medical and dental expenses
- Paid mortgage interest or real property taxes on your home
- Had large “other itemized deductions” (line 16 on Schedule A of Form 1040)
- Had large unreimbursed casualty or theft losses from a federally-declared disaster
- Made large contributions to qualified charities
Who doesn’t qualify for the standard deduction?
In some cases, you might not qualify to take the standard deduction. If one of the following situations applies to you, you’ll have to use the itemized deduction method.
- Your filing status is married filing separately, and your spouse itemizes deductions on their return.
- You are filing a tax return for a short tax year because of a change in your annual accounting period.
- You are a nonresident or dual-status alien during the year. (You are considered a dual-status alien if you were both a nonresident and resident alien during the year.)
What are the standard deductions?
If you qualify for the standard deduction, use the values below to determine what standard filing amount you qualify for.
| Filing status | 2021 | 2022 | 2023 |
|---|---|---|---|
| Single | $12,550 | $12,950 | $13,850 |
| Married filing separately | $12,550 | $12,950 | $13,850 |
| Married filing jointly | $25,100 | $25,900 | $27,700 |
| Widowed spouses | $25,100 | $25,900 | $27,700 |
| Head of household | $18,800 | $19,400 | $20,800 |
What form do you need to deduct interest from home equity loans?
The IRS tax Form 1098 — also known as your mortgage interest statement — shows the amount of combined interest you’ve paid on your first mortgage as well as any home equity loans or HELOCs you may have.
You’ll need this form if you want to deduct the interest payments you made on your primary mortgage, home equity loan, or home equity line of credit. Your loan servicer should send you Form 1098 by January 31.
If you haven’t received it by then, call your lender or check online through your mortgage servicer’s website. It’s important to note that if the interest you’ve paid on your first mortgage plus your home equity loan interest is less than $600, your loan servicer is not required to send you Form 1098. That said, you should still be able to find the information online.
Is a home equity loan better than a home equity line of credit?
There are plenty of good reasons for either a home equity loan or a line of credit. This is especially true compared to a personal loan, where you definitely can’t get a tax deduction on the interest you pay. But which option you choose really depends on how you plan to use the money, how you’d prefer to pay it back, and if the money is tax-deductible.
A home equity loan is best if you have a specific need for a lump sum of money and you’re comfortable taking on a second mortgage payment. Since this is a fixed-interest rate loan, you should also prefer predictable monthly payments.
If you’re not necessarily sure what you want to do with the money but still want cash available (like for an emergency expense), then a variable interest rate line of credit might be the better option for you. One of the best things about a HELOC is that you can borrow as much or as little as you need at any given time and are only required to pay interest on the money during the draw period.
Just remember that none of the HELOC or home equity loan interest is tax deductible unless you use the money to make significant improvements to the property. According to the IRS, this means the improvements must “add to the value of your home, prolong your home’s useful life, or adapt your home to new uses.” For example, new furniture may improve the look of the home, but it does nothing for its value.
Key Takeaways
- The interest paid on a home equity loan or line of credit is tax-deductible as long as the home equity proceeds are used to “buy, build, or substantially improve” the home.
- You cannot deduct interest from a home equity loan or line of credit if you used the funds for debt consolidation, education expenses, or anything else that doesn’t directly add value to the property.
- How much interest you can deduct is dependent on how you use the funds and the combined total of all your mortgage loans. This includes your first mortgage and any home equity loan or line of credit.
- Tax Form 1098 lists the interest you’ve paid on the mortgage for your primary residence and any home equity loan interest. You’ll need this information to fill out your tax returns.
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