Is Home Equity Loan Interest Tax Deductible?
You can write off home equity loan interest as long as you used the funds to renovate your home. You’ll need to know how to document these expenses, however — we’ll cover how to do that as we answer the question, “Is home equity loan interest tax deductible?”
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Should I deduct interest on my home equity loan?
You should consider deducting the interest on your home equity loan if you used the cash to “buy, build or substantially renovate your home,” according to the IRS. If the funds were used for any other reason — to consolidate debt, buy a new car or any purpose besides home improvement — the deduction doesn’t apply.
This rule has been in effect since Dec. 15, 2017, when the Tax Cut and Jobs Act (TCJA) was passed.
Rules on deducting home equity loan, HELOC or second mortgage interest
The home mortgage interest deduction allows you to deduct interest paid on your home equity loan in a given year. Under the current guidelines, taxpayers who took out a home equity loan after Dec. 15, 2017, can apply the deduction to:
- Interest paid on up to $750,000 of their mortgage debt for individual taxpayers and married couples filing jointly if the loan was used to buy, build or improve their main home or second home
- Interest paid on up to $375,000 of their mortgage debt for married couples filing separately if the loan was used to buy, build or improve their main home or second home
Under these rules, you could potentially deduct home equity loan interest up to the maximum limits if you:
- Buy a primary residence or second home using a home equity loan or HELOC
- Build a primary residence or second home using a home equity loan or HELOC
- Make home improvements to your primary residence or second home using a home equity loan or HELOC
- They’re taking out an 80-10-10 loan to avoid mortgage insurance.
- They’re buying a new home while they’re waiting for their current home to sell.
In the first scenario, you can avoid mortgage insurance if you take out the first mortgage to 80% and finance another 10% with a home equity loan. This is also called a piggyback loan. Mortgage insurance protects lenders against losses on mortgages they make to homebuyers with less than a 20% down payment.
In the second example, your home sale proceeds are typically used to pay off the home equity loan balance, leaving you with just the payment on the first mortgage.
What you’ll need to claim the home equity loan interest deduction
- Copy of the 1098 form. You should receive a Form 1098 from your current loan servicer at the end of the year. The amount listed in Box 1 shows the amount of interest you paid.
- Copy of your closing disclosure. You’ll receive a closing disclosure three business days prior to closing, which provides a breakdown of all the costs paid when your home was purchased.
- Copy of your loan application. Also called a uniform residential loan application, have a copy handy as added proof that the home you purchased was a primary residence or second home.
- Copies of your home improvement expenses. Keep your invoice, receipts and work orders to prove you used your home equity loan funds for improvements.
Other tax breaks for homeowners
You may be eligible for a variety of tax breaks for buying a home. Below are some of the most common ones:
Mortgage interest on your first home loan. If you currently have a first mortgage, you may deduct the mortgage interest you paid in addition to your home equity loan interest. However, there’s one exception: If you tapped your equity with a cash-out refinance by borrowing more than you owed on your previous mortgage, you won’t be able to deduct the interest for the higher loan amount unless it was used for home improvements.
Mortgage points. A mortgage point — more commonly called a “discount point” — is money paid upfront in exchange for a lower rate. In most cases, mortgage points are deducted over the life of the loan, but you can write them off in the year you pay them if the following conditions are met:
- The loan is secured by your primary residence or second home
- The points didn’t cost more than what’s typically charged in your area
- The points weren’t paid to replace other closing costs, like title or appraisal fees
- The points were figured as a percentage of your principal balance and are clearly shown as discount points on your settlement statement
State and local taxes. The current tax laws allow you to deduct state and local taxes of up to $10,000 for single taxpayers and married couples that file jointly. The deduction limit drops to $5,000 for married couples that file separate returns. As with point deductions, you’ll have to itemize to get a tax break with property taxes.
Capital gains on the sale of your home. Capital gains tax laws allow you to keep a portion of the profits tax-free when you sell your home. Married couples may qualify to keep up to $500,000 of their sale-related gains tax-free; for individual filers, the number is $250,000. If you lived in the home as your primary residence for two of the last five years before it was sold, you’d be eligible for this tax benefit.
Home office deduction. If some of your home’s square footage was used for business purposes, you may be eligible for this deduction. You’ll need to prove the home address is the same as your business location. You can take the deduction based on a percentage of how much of your home is used for business, or based on a flat $5-per-square-foot rate for up to 300 square feet. One caveat: You can’t claim the deduction if you work remotely.
What to expect for the 2023 tax year
One change worth noting for homeowners filing their 2023 taxes: The itemized deduction for mortgage insurance premiums is no longer available. You won’t be able to claim the deduction for mortgage insurance you’re paying, since it expired in 2021.