If you’ve recently taken out a home equity loan, you may be wondering if it is tax-deductible. While there isn’t a simple yes or no answer to this question, it’s important to understand the specifics of tax deductions for home equity loans. In this blog, we’ll cover the basics of home equity loans, including what they are and when they might be tax-deductible.
We’ll also discuss when a HELOC may not be tax-deductible and provide guidance on how to claim a home equity loan interest deduction. Lastly, we’ll discuss other factors you should consider before applying for a home equity loan and provide you with a bottom line on home equity loans and their tax implications.
What is a Home Equity Loan?
A home equity loan allows you to borrow a set amount based on the equity of your home, and the amount you can borrow depends on the value of your property and your existing loan balance. Nevertheless, most lenders require borrowers to have a combined loan-to-value ratio of no more than 85%. The interest on a home equity loan can be tax-deductible if the loan is used to buy, build, or substantially improve your home, and you file your taxes jointly or individually. However, the new tax laws under the TCJA affect those taxpayers who have opened home equity loans after December 16, 2017. These loans can only be tax-deductible if the total mortgage debt limit is $750,000, while married filing separate taxpayers can only deduct interest on loans up to $375,000. If you need to finance a home renovation project, a home equity loan may be a smart financial option, with lower interest rates compared to other types of loans.
Is Interest on Home Equity Loans Tax-Deductible?
Home equity loan interest can be tax deductible if used to buy, build, or improve a home. You can claim up to a maximum of $750,000 or $1 million for loans before 2018. However, if home equity loans are used for any other purpose besides home improvements, the interest deduction may not be viable. Investment homes are not eligible for interest deductions but have other tax deductions.
It’s important to note that interest on home equity loans is not tax deductible if not used to buy, build or significantly improve a home. Thus, before opting for a home equity loan, make sure it’s for a home improvement project, otherwise, it may not be of many tax advantages for you. Consult with your tax advisor, and ensure any equity loan you take is compliant with the tax code.
When is a HELOC Not Tax Deductible?
Home equity loans, also known as HELOCs, are generally tax-deductible if the money is used to buy, build, or improve your primary or second home. However, interest on a HELOC used for other purposes, such as paying for college tuition or consolidating credit card debt, is not tax deductible. Additionally, HELOC interest can only be deducted if the loan was used for significant home improvement.
After the Tax Cuts and Jobs Act of 2017, HELOC interest is no longer automatically tax deductible. Instead, the loan amount and purpose must meet IRS guidelines for it to be tax deductible. Homeowners who plan to take out a HELOC should be mindful of these regulations and consult with a tax professional to ensure that their loan is compliant with IRS rules.
How to Claim a Home Equity Loan Interest Deduction
Home Equity Loan interest is tax-deductible, provided that the funds are used to buy, build, or improve your main or secondary property, including a vacation home. You can deduct interest on up to $750,000 of home equity loans, depending on whether the loan was taken before or after December 15, 2017. However, you must use IRS Form 1040 to itemize your tax return to claim the deduction. If eligible expenses exceed the standard deduction, it becomes worth doing so. Married couples who file their taxes separately can only claim a deduction on interest paid up to $375,000. Interest paid for investment homes is not tax-deductible, but other tax deductions may apply. It’s important to note that these tax deduction limits will expire on December 31, 2025, unless extended or amended by Congress.
Are There Other Factors to Consider?
Home equity loan interest can be tax deductible if the funds were used to buy or improve a home. However, it’s essential to note that investment homes are not eligible for a home equity loan tax deduction. How much of the interest on a home equity loan is tax deductible relies on the amount and the time of the loan. Additionally, home equity loan funds used for anything other than home improvements are not tax deductible. Taxpayers can only deduct interest on up to $750,000 of residential loans, including mortgages, home equity loans, or HELOCs. It’s crucial to consult with a tax professional for proper advice on what is and isn’t tax-deductible. There are other factors to consider when applying for a home equity loan as it may negatively impact your credit depending on how you use the funds, and inability to repay can result in foreclosure. Always research all options and consider speaking to a financial advisor before applying for a home equity loan.
Bottom Line on Home Equity Loan Tax Deductions
The interest on a home equity loan is tax-deductible if the loan is used for home renovation purposes. Moreover, taxpayers can deduct the interest on up to $750,000 of residential loans. However, it’s essential to note that the limits on tax deductions for home equity loans will expire on December 31, 2025. The interest on a home equity loan is tax-deductible for both your first and second homes, but not for investment homes. The IRS also states that interest paid on home equity debt may still be tax-deductible, at least in some cases. It’s always best to consult a tax expert to ascertain the tax implications of taking out a home equity loan.
Frequently Asked Questions
Under what circumstances are home equity loan interest payments tax-deductible?
Home equity loan interest payments are tax deductible if the loan was used to buy, build, or improve a home, with a deduction limit of $750,000 for residential loans, including mortgages and home equity loans. However, if the loan proceeds were not used for home improvements, the interest payments are not tax deductible.
It’s worth noting that while tax reforms in 2017 removed some deductions for home equity loan interest, this deduction remains intact as long as the loan was used for home improvements. This deduction applies to both first and second homes, but not investment homes.
What are the requirements for claiming a tax deduction for home equity loan interest payments?
To claim a tax deduction for home equity loan interest payments, homeowners must meet certain requirements. The loan interest is tax deductible up to $750,000 for equity loans or $1 million for loans taken before 2018 when used to buy, build, or improve a home. Homeowners must also itemize deductions using IRS Form 1040 and ensure their expenses exceed the standard deduction.
Interest on up to $750,000 of home mortgage debt can be claimed as a tax deduction on any filing status except married filing separately. However, homeowners cannot claim the interest deduction on investment homes, and home equity funds used for purposes other than buying, building, or improving your home cannot be claimed as a tax deduction.
Can the tax deduction for home equity loan interest payments be used for home improvements or other expenses?
The tax deduction for home equity loan interest payments can be used for home improvements or building, up to $750,000. However, it only applies to first or second homes and not investment properties.
It’s important to note that unused home equity funds cannot be tax-deductible, and there is a $1 million limit for loans taken before 2018. Also, the interest deduction is only available to the amount spent on home improvements.
Are there any restrictions on the amount that can be deducted for home equity loan interest payments?
Yes, there are restrictions on the amount that can be deducted for home equity loan interest payments. The tax deduction is available if the loan is used for home buying, building, or improvement up to $750,000. For married couples, the interest can be deducted up to $750,000, while for someone filing separately, it is up to $375,000. However, interest on home equity loans that are not used for home purposes is not tax deductible.
The tax deduction rules for home equity loans are the same as those for first or second-mortgage loans. The limits on deductions were set by the Tax Cuts and Jobs Act of 2017 and will expire on the last day of 2025.
In conclusion, the tax deductibility of home equity loans depends on the purpose of the loan and how you use the funds. Interest on home equity loans and HELOCs are generally tax-deductible if the loan was used for home improvements, debt consolidation, or other expenses related to your home. However, there are certain situations where the interest may not be deductible, such as if the loan was used for a rental property or if the total mortgage debt exceeds the value of the home. It’s important to consult with a tax professional or financial advisor to understand the tax implications of a home equity loan. Still, have more questions? Check out our comprehensive guide on everything you need to know about home equity loans and taxes.