Does Your HELOC Have Tax Benefits

Also referred to as second mortgages, home equity loans and home equity lines of credit (HELOCs) allow homeowners to tap into their home equity in order to buy another home, pay for home improvements, consolidate debt, or cover personal expenditures. Whether you’ve taken out a home equity loan or HELOC, it’s essential to know if there are any tax benefits you may be eligible for.

Tax Rules for Home Equity Loans and HELOCs

Regardless of the reasons why you’ve decided to use a home equity loan or HELOC, one important consideration is that not all home equity loan interest is deductible. In short, a taxpayer can deduct the interest paid on any of these loans only if they’ve been taken out for an IRS-approved use.

The IRS doesn’t provide a full list of expenses that allow you to deduct home equity loan or HELOC interest. However, it clearly indicates that homeowners can deduct interest only if the borrowed money is used to buy, build, or improve a primary or secondary residence. This simply means that the interest paid on the home equity loans or HELOCs taken out for non-house-related projects isn’t deductible.

As an example, building an addition to your home, replacing your old roof or HVAC system with a new one, and completing an extensive bathroom or kitchen remodeling project are some of the IRS-approved uses that may qualify your home equity loan or HELOC for an interest tax deduction. On the other hand, you cannot take the deduction if you use the loan to pay for a vacation or wedding, buy a car, or pay off debt.

How to Deduct Interest on Home Equity Loans and HELOCs

Claiming a home equity loan or HELOC interest deduction isn’t difficult. To deduct the interest paid, you’ll need to itemize deductions using the IRS Form 1040. However, there are some tax-deductibility limits you should be aware of. To begin with, you can deduct interest on first and second mortgages of up to $1 million, if the loans were taken out before December 15, 2017. After that date, the limit goes down to $750,000 if you’re single or married and filing a joint return, or upto $375,000 if you’re married and filing separately.

A notable point is that the aforementioned limits apply to the combined amount of all the loans secured by your property and used for home-related projects. For example, if you have a $550,000 mortgage, you could deduct interest on up to a $200,000 home equity loan or HELOC, provided you used the loan after December 15, 2017. That’s because the $550,000 mortgage together with the $200,000 home equity loan or HELOC puts you at the current limit of $750,000. If you spent the money before the aforementioned date, you’d be subject to the $1 million limit.  

Additionally, deducting interest on your first and second mortgages is worth doing only if the total amount exceeds the amount of the standard deduction for tax year 2021, which is $25,100 for married couples filing jointly, $12,550 for single taxpayers or married people filing separately, and $18,800 for heads of household.

Because you can either itemize or take the standard deduction, it’s important to compare your itemized expenses to the deduction you may qualify for. Let’s say you paid $2,400 in interest on a home equity loan or HELOC and $8,600 in interest on your mortgage last year. Whether you’re filing a joint return or you’re a single filer, $11,000 ($2,400 + $8,600) is lower than the standard deduction of $25,100 or $12,550, respectively. However, depending on your financial situation, itemizing deductions could still make sense. Therefore, it’s wise to consult with a tax professional before proceeding. 

Now that you know what you can do with a home equity loan or HELOC and how you can deduct interest on these loans, it’s important to find out how much money you can actually borrow. In general, homeowners can borrow up to 80% of their homes’ value. As an example, if your home’s current appraised value is $380,000, and your outstanding mortgage balance is $100,000, that leaves you with $204,000 of equity to borrow with a loan.

Although it may seem more advantageous to take out a home equity loan or HELOC in order to buy, build, or improve a piece of property, these loans typically carry lower interest rates than consumer loans. Therefore, tapping into your home equity to cover personal expenditures or to pay off debt could work to your advantage in the right circumstances. If you’re looking for ways to take equity out of your home either for house-related projects or personal expenses, our professionals can help you find a home equity loan or HELOC with terms and conditions that perfectly fit your financial situation.

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