Have you always dreamed of installing a pool in your backyard or finally adding that guest bedroom but simply don’t have the funds on hand? Maybe, instead, you simply need to get out from underneath debt or finance an unexpected expense. Home equity loans and home equity lines of credit are just the tools for these situations. Both allow homeowners to borrow against the equity they own in their house and use the funds however they like.
You may have also heard that the interest you pay on home equity loans and credit lines is tax deductible. While this may be true in some situations, it’s not the case in all.
Is home equity loan interest tax deductible?
Whether the interest is tax deductible primarily comes down to how the funds are used. You will need to consult a tax professional for advice regarding your situation and a definitive response to this question. According to the IRS, interest on home equity loans and lines of credit is deductible only if the taxpayer who secures the loan uses the borrowed funds to buy, build or substantially improve their home.
While the IRS hasn’t defined what “substantially improve” means, it is generally considered to include anything that increases the value of your home. Think replacing a roof, adding a bedroom, remodeling a bathroom and such.
On the other hand, if you take out a home equity loan to pay off another debt or finance an emergency expense, for example, the interest is not tax deductible.
The same tax rules regarding home equity loan interest apply to home equity credit line interest.
Is there a cap on how much interest you can deduct from a home equity loan or credit line?
You can only deduct interest on up to $750,000 worth of mortgage debt ($375,000, if filing separately). This includes both the original mortgage used to purchase your house and the home equity loan or credit line.
How do I claim a home equity interest tax deduction?
Interest on home equity loans and credit lines can be deducted only if you itemize your tax return. If the total interest paid in one tax year is less than the standard deduction, you may be better off foregoing the itemized deduction. Consult your tax and/or financial advisor.
To claim your tax deduction, you’ll first need to gather the proper documents. You should receive IRS Form 1098 from your lender prior to tax season. This document shows how much interest you paid on your home equity loan or credit line the previous year.
You will also need to prove in the form of receipts and invoices that the funds went toward home improvements. This can include payments for materials, labor and permits, among other expenses.
AAA Northeast is not a professional tax service, nor does it provide tax advice. You should always consult a tax and/or financial advisor for guidance on your specific financial situation and tax obligations.
Interested in learning more about home equity loans? Let your home work for you with AAA!