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Understanding the HELOC Tax Deduction

In Home Financing Advice
Couple looking at paint colors in living room

Owning a home not only gives you a place to make memories with your loved ones, but it also offers you the ability to build equity. Home equity is the value of your home, minus any loans that you have for the remaining balance on your home. As you pay off your mortgage, your home equity increases and will fluctuate based on the current market price of your home.

Many homeowners use this equity to their advantage by leveraging it to secure a home equity line of credit (HELOC). This means that lenders accept your home equity as collateral in the case that you fail to repay any money that they have lent you.

How do I use a HELOC

Home equity lines of credit are a similar concept to a credit card. You can use this line of credit to make large purchases with money borrowed against the equity in your home. Once you repay the money, your credit availability is replenished.

When you borrow money with a HELOC, you typically have a fixed interest rate.

In the past, you could deduct this interest from your taxes on up to $100,000 of debt, regardless of how you used this money. However, the rules have changed due to the Tax Cuts and Jobs Act of 2017.

Is HELOC interest still tax-deductible?

According to the IRS, after the Tax Cuts and Jobs Act of 2017 passed, you can only deduct interest on HELOC debt if the money you borrow is used for renovations to your home. In other words, if you “buy, build, or substantially improve” your home. This renovation or investment must be on the same home that you are borrowing against.

To qualify for this deduction, the improvements you make on your home must increase its value. Maintenance costs do not count.

For example, if you are repainting the living room or removing old wallpaper, this does not qualify. Building an extension or remodeling your kitchen or bathroom are examples of substantial improvements that are tax-deductible.

What if I am buying a second home?

If you are buying a second home, the money used to pay for the home must be secured by the second home for any interest to be tax-deductible. If you use credit from an existing home to purchase a second home, this interest is not deductible.

How much interest is deductible?

Under the new terms of the Tax Cuts and Jobs Act, interest is deductible on loans up to $750,000 secured by home equity for individuals who are single or married filing jointly. If you are married filing separately, the limit is $375,000. This limit of $750,000 is a total limit, meaning that this takes into account the total amount you are borrowing for residential properties.

If you have two homes, with two loans secured by home equity, the total value of this borrowed money must be less than $750,000, or else the total interest is not deductible. Instead, a percentage is deductible according to Publication 936 from the IRS.

How do I keep track of HELOC tax deductions?

To make sure that you can take advantage of all tax deductions guaranteed to you, it is important to be meticulous about keeping records of any home improvements you make. Talking with an accountant about how best to organize these files can help you make sure you do not miss out on any deductions. Keeping all of your receipts is a good place to start.

Another helpful tip is to keep track of all of your bank statements. You want to be able to prove where all of your money went, which will be invaluable if you ever get audited by the IRS. One spot you want to sidestep is having to pay penalties and back taxes because you don’t have your paperwork in order.

It’s also a good idea to keep your credit line uses separate. For example, technically, you can use a HELOC to pay for any expenses. It’s just that these expenses will not be tax-deductible. If you borrow money with a HELOC and use half to pay for your child’s tuition and half to pay for a kitchen remodel, it can get tricky to track. It’s wise to keep these expenses separate, wherever possible, to ensure it is easy to track and prove where your money has been spent.

How do I claim the HELOC tax deduction?

When you file your taxes, you will itemize your deductions on the IRS Form 1040. Taking Advantage of the Versatility of HELOCs Even if you are not able to claim your interest as a deduction, HELOC loans can offer much lower interest rates and better value than many other avenues of lending.