In many cases, if you use a home equity loan or home equity line of credit (HELOC) to substantially renovate or improve your home, the interest you pay is tax-deductible. If you use the loan for any other purposes, such as for personal expenses, the interest will not be tax-deductible. According to the IRS, and as an example, interest on a home equity loan used to build an addition to an existing home is typically deductible. Interest on that same loan used to pay personal living expenses, such as credit card debt or electric bill, is not. The loan must also be secured by the taxpayer’s main home or second home, which is known as a qualified residence. The loan should also not exceed the cost of the home.
A couple filing jointly may only deduct interest on $750,000 of qualified residence loans. This limit applies to the combined total of loans used to buy, build, or substantially improve a taxpayer’s main home and second home. Prior to tax law changes, taxpayers were allowed to deduct qualifying home loan interest on loans up to $1 million. The $750,000 cap will include the total of mortgage loans, as well as home equity loans and HELOCs, and is not to exceed the cost of the property. As an example of this, a couple has a $600,000 mortgage on their $750,000 home. They obtain a $100,000 home equity loan to complete a large home renovation project that qualifies for the interest deduction. The $700,000 total in home loans does not exceed the $750,000 threshold and does not exceed the cost of the home. For these reasons, the interest paid is deductible. Complete details and clarification on deducting home loan interest can be found on irs.gov.
Interest on home equity loans and HELOCs is tax-deductible in certain cases
As we mentioned above, for the interest to possibly be tax-deductible, the loan must be used for your first or second home. The home mortgage interest deduction was not meant for investors with many properties, but rather for a homeowner to take advantage of for their primary or secondary residence. In addition, the funds must be used for significant home improvements that add value to your home or prolong the useful life of your home. Significant improvements refer to improvements beyond general repairs or routine maintenance. They are projects which can improve the value of your home. In general, cosmetic improvements such as new paint or planting shrubs won’t count.
Examples of home equity loan expenses eligible for tax-deductible interest
- Room additions & new construction
- Home additions that add value to your home
- Putting a new roof on your home
- Replacing your HVAC system
- Substantially improving a kitchen
- An extensive bathroom remodel
- Electrical or plumbing upgrades
- Finishing an unfinished basement
Examples of non-eligible expenses
- Debt consolidation
- Emergency fund
- Cosmetic home fixes, such as new paint, furniture, or décor.
- Landscaping
- Vacations
- Tuition costs
- Auto expenses
- Medical expenses
- Other personal expenditures
Deducting home equity loan interest
Sometime in January, you should receive a form 1098 from your mortgage and home equity loan lenders. The form will provide the amount of interest you paid on your loans for the previous year. Keep in mind that you need to itemize deductions to take advantage of the tax break. Be sure to keep receipts and invoices from all of your qualifying home equity loan expenditures. IRS Publication 936 can be used for additional information and help in understanding home mortgage interest deduction.
In conclusion, the interest on a home equity loan or HELOC may be tax deductible if it:
- Was secured by a taxpayer’s principal home and/or second home, and
- The funds were used to acquire, construct, or substantially improve a home.
We understand there may be confusion over the laws regarding deducting home equity loan interest and hope this information helps. If you still have questions or want to know whether or not the interest on a particular home equity loan expense will be tax-deductible, we recommend you speak to your tax advisor. Learn more about Choice One Community Credit Union home equity loans on our website.