Is Heloc Interest Deductible and What You Need to Know

If you're considering taking out a Home Equity Line of Credit (HELOC), you're probably wondering if the interest is deductible. The answer is yes, but there are some rules you need to follow.

To qualify for a HELOC interest deduction, your home must be your primary residence or a second home, and you must use the loan proceeds for home improvements.

The IRS allows you to deduct interest on up to $750,000 of home equity debt, but only if the debt was used for home improvements.

A unique perspective: How to Use a Heloc to Buy a New Home

To qualify for interest deduction, the home equity line of credit must be secured by a "qualified home", which generally includes your main home and a second home, as long as they meet specific criteria.

The primary factor that determines the tax deductibility of home equity loan interest is the purpose for which the funds are used. According to the Tax Cuts and Jobs Act, interest on Home Equity Loans is only tax deductible if the funds are used to "buy, build, or substantially improve" the home that secures the loan.

Explore further: Interest Rate Impact on Equity Market

The interest deduction is subject to a dollar limit, which is up to $100,000 for individuals and up to $50,000 for married couples filing separately. This limit applies to both Home Equity Loans and HELOCs.

Here are some examples of what counts as a substantial improvement to your home, making your home equity loan interest tax deductible:

If you only use part of the loan on home improvements, you should calculate your tax deduction accordingly.

The tax guidelines and limits for home equity loan interest can be complex, but I'm here to break it down for you.

The Tax Cuts and Jobs Act of 2017 suspended the deduction for home equity loan interest from 2018 through 2026, but there's an important exception.

Prior to 2018, interest from home equity loans and HELOCs was deductible regardless of how the loan was used, but that's no longer the case.

On a similar theme: Do I Have Enough Equity for a Heloc

The IRS has put limits in place for home equity loan interest tax deductions, with a maximum loan amount of $750,000 for people who are married and filing jointly, and $375,000 for single filers and those who are married and filing separately.

The limits apply to the combined amount of all loans secured by a property, including primary mortgages and home equity loans or HELOCs.

If you took out a mortgage before Dec. 16, 2017, you can deduct the interest on mortgage debt (including HELOCs) that total $1 million or less ($500,000 if married filing separately).

If you took out a mortgage after Dec. 16, 2017, you can deduct the interest on mortgage debt totaling $750,000 or less ($375,000 if married filing separately).

To qualify for the tax deduction, you must use the borrowed money to "buy, build or substantially improve" the home securing the loan.

Some examples of substantial improvements include building an addition to your home, undertaking substantial renovations, installing a new roof, installing a new HVAC system, or doing extensive landscaping.

To calculate your tax deduction, you should determine how much of the loan was used for home improvements and deduct the interest accordingly.

Here's a summary of the limits:

Remember, these limits are subject to change, and it's always a good idea to consult a tax professional or contact your local IRS office to ensure you're meeting the requirements.

To claim the HELOC interest deduction, you'll need to follow some specific steps. You must itemize your deductions on Schedule A if you want to deduct your loan interest.

First, you need to file Form 1040 or Form 1040-SR and itemize your deductions on Schedule A. You'll also need to get your Form 1098 from your lender, which you'll receive if you pay more than $600 in loan interest during the tax year.

To claim the deduction, the mortgage or loan must be a secured debt on a qualified home in which you have an ownership interest. You're required to disclose if you didn't use the funds from your loan for one of the qualifying purposes by checking the box next to Line 8 on Schedule A.

You'll need to enter the information on Form 1098 in Line 8 of Schedule A and complete the rest of Schedule A to calculate your total deductions. Then, fill in your total deduction amount on Line 17 of Schedule A and transfer it to Line 12a on your Form 1040 or Form 1040-SR.

Consider reading: Day Trader Tax Deductions

Here's a step-by-step checklist to help you claim the HELOC interest deduction:

The Tax Cuts and Jobs Act (TCJA) of 2017 significantly changed the rules for deducting home equity loan interest. If you closed escrow on a HELOC or home equity loan before December 15, 2017, you could deduct interest on up to $1 million of debt if filing jointly and up to $500,000 of debt if filing separately.

However, since TCJA went into effect, joint filers who borrowed after that date can deduct interest on up to $750,000 of debt, and married people who file on their own can deduct home equity loan interest on up to $375,000 of debt.

The new tax reform bill eliminated the home equity loan interest deduction for non-qualified purposes, meaning you can no longer deduct interest on funds borrowed for non-qualified purposes, such as paying off credit card debt or financing a car.

Readers also liked: Heloc Percentage of Equity

Home equity loan interest is only deductible for qualified purposes, such as improving your home or paying for home renovations. If you used your home equity loan for qualified purposes, you may be eligible to deduct the interest on your taxes.

Here's a summary of the changes:

It's essential to stay informed about potential future changes in tax regulations that may affect the deductibility of home equity loan and HELOC interest.

If you own a rental property, you can deduct the interest on your home equity loan if you meet two key qualifications. The rental property must secure the home equity loan, and you must use the loan proceeds for substantial improvements to the property.

For example, if you take out a HELOC to build a new bathroom in your rental property, the interest you pay on the loan may be tax deductible. As long as you itemize deductions and meet the qualifications, you can claim this deduction on your taxes.

You'll need to keep careful records of your expenditures, including receipts and invoices, to prove that you used the loan for substantial improvements. This will come in handy if you're audited by the IRS.

Additional reading: Heloc on Investment Property in Texas

If you own a rental property, you may be able to deduct the interest on your home equity loan, but only if you meet certain qualifications.

The rental property must secure the home equity loan, and you must use the proceeds of the loan to pay for substantial improvements to the rental property.

To qualify for the tax deduction, keep careful records of your expenditures and be prepared to present those records to your accountant and the IRS in the event of an audit.

Here are the specific requirements to qualify for the tax deduction:

For example, if you take out a HELOC to build a third bathroom in your main bedroom, the interest you pay on the loan may qualify for a tax deduction, as long as this is a first or second home and you itemize deductions.

You'll file Form 1040 or 1040-SR during tax season to itemize deductions, including mortgage interest.

Mortgage companies send you Form 1098, Mortgage Interest Statement, at the end of the year to help you fill out the form.

The standard deduction for 2022 is $12,950 for single filers, $25,900 for joint filers, and $19,400 for heads of household.

If your mortgage interest and other itemized deductions don't surpass the standard deduction, taking the standard deduction may be the way to go.