One significant advantage of home equity loans over other types of financing is the potential for tax-deductible interest. However, this benefit is only available under certain conditions. The amount you can deduct depends on when you took out your loan and, more importantly, how you plan to use the funds.
Is the Interest on Home Equity Loans Tax-Deductible?
Only the interest on a home equity loan is tax-deductible, not the loan principal. Whether you can deduct the interest depends on several factors: when you took out the loan, how much you borrowed, the purpose of the funds, and whether it’s more advantageous for you to itemize deductions or take the standard deduction.
Rules and Limitations of Home Equity Tax Deductions
Previously, you could take out a home equity loan, use it for almost any purpose, and fully deduct the interest on your tax return. However, the Tax Cuts and Jobs Act of 2017 changed these rules significantly.
1. Usage of Funds: For the interest to be tax-deductible, the money must be used to "buy, build, or substantially improve" the primary or secondary home securing the loan. This means interest on home equity loans used for paying off debts, covering emergency expenses, or starting a new business is not deductible.
2. Amount of Interest Deduction: The law also limits the amount of interest you can deduct. For loans taken out after December 15, 2017, joint filers can deduct interest on up to $750,000 of qualified loans, while separate filers and singles can deduct interest on up to $375,000. For loans taken out before this date, the limits are higher: $1 million for joint filers and $500,000 for separate filers and singles. These limits include any existing mortgage loans. For example, if you have a $500,000 mortgage balance, only $250,000 of home equity loan debt is eligible for a tax deduction.
Tax-Filing Status Home Equity Loan Closing Date Debt Limit for Interest Deduction
Filing jointly/single Before Dec. 15, 2017 $1,000,000 / $500,000
Filing jointly/single After Dec. 15, 2017 $750,000 / $375,000
Example Scenario:
In 2022, if you took out a $200,000 home equity loan and used half for paying off credit card balances and the other half for constructing a new home office, only the interest paid on the $100,000 used for the home office would be tax-deductible.
Another key requirement is that taxpayers must itemize their deductions to claim the interest deduction, rather than taking the standard deduction.
Are HELOCs Also Tax-Deductible?
Home equity lines of credit (HELOCs) have similar tax-deductibility rules. To qualify, the funds must be used to buy, build, or substantially improve the home securing the loan. Interest on HELOCs used for paying off student loans, college tuition, or consolidating credit card debt is not deductible. Additionally, you can only deduct interest on a HELOC used to buy a second or vacation home if that home is the collateral for the loan.
How to Claim a Home Equity Loan Interest Deduction
1. Understand Your Mortgage Situation: Your first mortgage is the loan you originally took out to buy the home, and the home equity loan is your second mortgage. Both must meet IRS requirements:
- Combined debt must not exceed $750,000 (or $1 million, depending on loan dates).
- Must be secured by a qualified residence (main or second home).
- Debt must not exceed the value of the residence.
- Funds must be used to acquire or substantially improve the residence.
2. Gather Necessary Documents: To claim the deduction, you’ll need
- Mortgage interest statement (Form 1098) from your lender showing total interest paid.
- Statement for any additional interest paid.
- Proof of how the loan funds were used (receipts, invoices).
3. Itemize Your Deductions:
Itemize your deductions if they total more than the standard deduction for the year. The standard deduction amounts for recent years are:
Tax Year Married Filing Jointly Filing Separately/Single Head of Household
2022 $25,900 $12,950 $19,400
2023 $27,700 $13,850 $20,800
2024 $29,200 $14,600 $21,900
If your itemized expenses, including home equity loan interest, are less than the standard deduction, it’s better to take the standard deduction.
Bottom Line on Home Equity Loan Tax Deductions
Interest on a home equity loan is tax-deductible if the funds were used to buy, build, or improve a home, as defined by the IRS. However, if the combined interest and other itemized deductions are less than the standard deduction, opt for the higher standard deduction.
Consult a tax professional for personalized advice. Even without the tax deduction, home equity loans and HELOCs can be financially advantageous due to their lower interest rates compared to credit cards and personal loans, making them a smart choice for paying off higher-interest debt.
