Need some extra cash for a home repair and have equity in your home? You might want to look at a home equity loan or a home equity line of credit, also known as a HELOC. Both are second mortgages and both are great options.
You’ll find some differences between a home equity loan and a home equity line of credit. The key difference is that a home equity loan is a fixed-rate loan for a set amount, and a HELOC is a revolving line of credit (like a credit card) that usually has a variable rate. One type of mortgage loan may be better depending on your situation and what you need the cash for.
Tapping either one not only helps finance your project – it could also lead to a bonus during tax season. Interest paid on HELOCs is sometimes tax deductible.
Home equity loan interest and HELOC interest are both tax deductible, but only under certain circumstances. It’s important to learn the ins and outs before you claim HELOC or home equity loan interest on your taxes.
New Rules for HELOC Interest Tax Deduction
Back in 2017, the IRS changed the rules about tax deductions on interest for HELOCs. They extended the new rules to also apply to HELOCs taken out before 2017. The determining factor in whether HELOC interest is tax deductible is how you use the cash from the HELOC.
The language attached to the current tax laws is “buy, build or substantially improve.” In other words, you can only deduct interest payments on HELOCs if you use the cash on home renovations.
As long as you meet the criteria, single filers and married couples can deduct the interest on a loan up to $750,000. If you’re married and filing separately, the maximum amount is $375,000. Mortgages taken out before tax year 2018 are covered under the previous limit of $1 million for single filers or married couples filing jointly, or $500,000 for married people filing separately.
The IRS doesn’t include a precise list of expenses covered under the interest deduction. But they do provide some broad examples:
- Adding a new room to your home
- Installing a new roof
- Renovating or remodeling your kitchen or bathroom
- Replacing an aging HVAC system
- Repaving your driveway
Bottom line: If you have equity in your home and you want to do some remodeling, you could potentially save some money by financing with a HELOC and deducting interest payments up to $750,000 on your tax return.
How Deducting HELOC Interest From Taxes Works Now
The loan proceeds you get from a HELOC aren’t considered taxable income. However, you might need to pay a mortgage recording tax when you take out the HELOC, depending on where you live.
You must use HELOC funds for home improvements to get the tax deduction. Because a HELOC is a line of credit using home equity as collateral, you can use the money on anything you want. You can use it to zero out some medical bills, pay off college debt or invest in a new business. Technically, you could also drop it on a wild month-long vacation in Vegas.
You just can’t deduct the loan interest on your tax return if you use it for any of those things.
The interest deduction only applies to renovations on the primary residence you got the HELOC for. To get the tax deductions, you can’t take out a HELOC on your home and use the borrowed funds to renovate an investment property, rental property or your second home in The Hamptons.
In 2023, tax benefits on HELOCs are available only to people who already itemize their deductions. Be aware that itemized deductions may not be higher than the standard tax deduction because the standard deductions have increased. For tax year 2023, standard deductions are $13,850 for single filers and $27,700 for couples filing together.
The fact is, most taxpayers simply take the standard deduction. By doing so, you lower your reported income by the standard deduction amount automatically, and you don’t need to keep any expense records or receipts. It makes preparing taxes much less stressful.
It all comes down to math. If your deductible expenses add up to more than the standard deduction for a tax year, you’ll fill out a Schedule A and itemize them. If this is the case, you can add the interest payments from your HELOC.
Just remember: No itemizing – no deduction.
What Items You’ll Need To Claim the HELOC Interest Deduction
Assuming your mortgage debt is less than $750,000, you already itemize your deductions on your tax returns, and you want some money to turn your back porch into a sauna, you’re all set. You’ll have tax breaks coming your way at the end of the year.
To deduct HELOC interest on your tax return, you’ll need a few different forms and documents:
- Form 1098, a Mortgage Interest Statement
- A copy of your closing disclosure
- A copy of your HELOC or loan application
You’ll also need records of all your home improvement expenses. Save all the receipts for each expense you incurred and copies of your bank statements. You won’t need to send these off when you file, of course, but it’s a good idea to tuck them away in case the IRS audits you. It’s rare, but it happens – better safe than sorry.
Improve Your Home and Get a Tax Break: A Win Win
Say you’re looking to do some serious renovations on your home and you meet the HELOC criteria. Great! A HELOC is a wonderful way to save some money at the end of the year by deducting the interest on your tax return.
Still, the laws surrounding home loan deductions are pretty complicated, so it’s always worth talking to a professional tax person or financial advisor before you sign on the dotted line.
Internal Revenue Service. “Interest on Home Equity Loans Often Still Deductible Under New Law.” Retrieved April 2022 from https://www.irs.gov/newsroom/interest-on-home-equity-loans-often-still-deductible-under-new-law
Internal Revenue Service. “IRS provides tax inflation adjustments for tax year 2023.” Retrieved January from https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2023