Home equity loan tax deduction
Do you currently pay interest on your first mortgage and home equity loan? If so, you may be wondering if home equity loans are tax deductible.
To save you some time, let’s go over the circumstances in which you certainly cannot deduct the interest on such loans when completing your federal tax returns:
- If you take the standard deduction on your tax return. You can only deduct mortgage interest if you itemize all your deductions
- If you used the proceeds of your loan for any purpose other than “to buy, build or substantially improve your home that secures the loan,” in the words of the IRS’s website. So, the interest on any money from the loan you used for other purposes will not be deductible
So, you’re still with us, having cleared those hurdles. Now carry on through the rest of this article to see if you could benefit on your federal tax bill.
Note: We are exploring only federal tax deductions for the 2022 tax year, filed in 2023. Those for state taxes will vary. This article is for general informational purposes only. The Mortgage Reports is not a tax website. Check the relevant Internal Revenue Service (IRS) rules with a qualified tax professional to ensure they apply in your personal circumstances.
In this article (Skip to...)
- What is a home equity loan?
- Is home equity loan interest tax deductible?
- Rules for deducting interest
- Limits to home equity loan tax deductions
- How to deduct home equity loan interest
- Is it worth using a home equity loan?
- Should I get a HEL or HELOC?
What is a home equity loan?
A home equity loan (HEL) is a type of second mortgage. That means the loan is secured by using your home as collateral. And, if you were to fall too far behind with payments, your lender could foreclose on the property.
The IRS calls this “home equity indebtedness.” And it includes home equity lines of credit (HELOCs) within that definition. So, the information in this article applies to both home equity loans and HELOCs.
Is home equity loan interest tax deductible?
Now we’re getting to the heart of our original question: Are home equity loans tax deductible? In principle, the answer is Yes. However, you can’t deduct the entire monthly payment on your HEL or HELOC. Only the interest on that borrowing is deductible.
To be eligible, you must abide by the rules and limits set by the IRS. In particular, you can only claim the deduction on sums from a HEL or HELOC that were spent on worthwhile home improvements. So keep your receipts from such projects to prove where the money went.
Rules for deducting interest on a home equity loan HELOC
Standard deduction vs. itemizing
You have a choice each year on whether to take the standard deduction on your IRS filing or itemize each of your deductions. Clearly, you’ll pick the one that reduces your tax bill more. However, you may decide to duck the hassle of itemizing if the benefit you get from doing so is minimal.
For 2023 filings, which cover the tax year 2022, the standard deductions are:
- Married couples filing jointly: $25,900
- Single taxpayers and married individuals filing separately: $12,950
- Heads of households: $19,400
So, are home equity loans tax deductible? Yes, but only if you itemize.
You can deduct the interest on your HEL or HELOC payments only on the proportion of that borrowing that was used to buy, build or substantially improve your home that secures the loan. So, if you used some of the proceeds for other things, you can’t deduct the interest on those items. They might include debt consolidation, medical expenses, a cruise, a wedding, or other spending that wasn’t for home improvements.
What constitutes expenses that “substantially improve your home?” Unfortunately, there’s no clear definition. But many suggest it means improvements that add worthwhile value to the property.
So, repairs, remodelings and additions are likely to qualify projects that improve your home. But check with your tax professional before you undertake work that may not add substantial value to your home. That might include installing a huge aquarium or a 20-car underground garage. These are things that many future buyers might value less than you do or even regard as a liability.
Limits to home equity loan tax deduction amounts
If you’ve used your home as collateral for significant borrowing, you may not be able to deduct the interest on your entire debt. In other words, there are caps on the deductible elements of these mortgage and home equity loans or lines of credit. The IRS explains:
“You can deduct home mortgage interest on the first $750,000 ($375,000 if married filing separately) of indebtedness. However, higher limitations ($1 million ($500,000 if married filing separately)) apply if you are deducting mortgage interest from indebtedness incurred before December 16, 2017.”
So, if your first and second mortgage(s) have balances over $750,000, you can deduct interest on only the first $750,000 of those. That assumes you’re married and filing jointly and your loans are dated after Dec. 16, 2017.
How to deduct home equity loan interest
Each year, you should receive a Form 1098 from the company or companies to which you make payments on your first and second mortgage(s). This lays out that year’s mortgage payments. And it breaks them down into interest and principal receipts. You can deduct only the interest payments.
You enter the sums you’re deducting, as shown on your 1098 forms, on the Schedule A part of the Form 1040 tax return.
Is it worth using a home equity loan if it isn’t tax deductible?
In many cases, home equity loans and HELOCs are likely to be the least costly forms of borrowing available to you.
Think of the tax deduction as the cherry on the cake. It may add a little to the appeal of the cake (or loan). But it’s probably not what made you want it in the first place.
Should I get a home equity loan or a HELOC?
If you’re a homeowner and need to borrow a significant sum, a HEL or HELOC might be a suitable choice. But which you choose will depend on your needs and preferences.
HELs are straightforward installment loans with fixed interest rates. You can make one fit your budget by choosing a term (the time the loan lasts), so you either have lots of smaller payments or fewer bigger ones. Since you’ll be paying closing costs regardless of the amount you borrow, it may be worth it to draw a larger sum.
HELOCs are more complicated and you should read up on them before choosing one. They act a bit like credit cards since you’re given a credit limit and can borrow, repay and borrow again up to that limit whenever you want. And you pay monthly interest only on your current balance. They tend to have smaller — sometimes zero — closing costs than HELs but come with variable interest rates.
As with most forms of borrowing, you’ll find a wide range of interest rates, loan fees, and costs available to you. So, it’s essential that you comparison shop for your very best deal. You could save thousands of dollars.
Let us help you with that. We can introduce you to lenders that can provide you with competitive deals. Compare their quotes (and others) and choose your least costly option.