Basics Of The Mortgage Interest Deduction
Home equity loan interest tax deductions are one of the multiple mortgage-related interest tax deductions that you may be able to claim. A mortgage can help you buy a home or borrow against a property you already own in the case of a home equity loan. It might even provide some tax benefits since the interest you pay is sometimes deductible.
Under the home mortgage interest deduction, the IRS allows you to deduct the interest you pay on any loan secured by your main home or a second home, including:
- Purchase loans
- Home equity loans , which provide a lump sum of cash up front
- Home equity lines of credit, which allow you to spend from a credit line
As of tax year 2021, you can only deduct interest on a home equity loans or home equity lines of credit if the loan amount is used to buy, build, or substantially improve the home against which the money was borrowed.
Energy Tax Credits Remain Consistent
One area that isnt changing much, at least on a Federal level, is home energy tax credits. In early 2018, the IRS renewed residential energy-efficiency tax credits that had expired at the end of 2016, says Walser. However since state tax credits can vary, discuss this topic with your accountant.
Walser also notes that some energy credits will start shrinking. For instance, solar installation credits will drop to 26% for tax year 2020, and 22% for tax year 2021. These reductions could speed up homeowners energy upgrade investments because both construction start date and placed in service date impact the amount of credit.
Limits On Deductions From State And Local Property Taxes
At the same time that the standard deduction is almost doubling, the new tax law also potentially reduces a homeowners ability to claim an itemized deduction for state and local real estate property taxes.
Starting with your 2018 return, you can no longer deduct more than $10,000 for state and local property taxes combined, or $5,000 if you are married but filing separately.
The impact of the change varies according to where you live and will have the greatest impact on homeowners living in states with high income and property taxes , says Walser.
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How Tax Plan Changes Affected Home Equity Loans And Helocs For 2018 And Beyond
Prior to 2018, there were no qualifications on the tax deductibility of interest paid on a home equity loan or HELOC. Borrowers could take out a home equity loan or HELOC for any purpose and still deduct the interest on their taxes.
Congress passed a new law in December 2017, however, that changed the way the IRS considers home equity loans and HELOCs. So if you take out a home equity loan or HELOC to consolidate debt, pay off credit card debt, buy a car, pay for medical expenses, go on vacation, or pay for college, the interest is no longer tax deductible. You can still use the loan proceeds in any way you want, but you will only be able to claim the interest deduction on your federal taxes under a few specific conditions.
From 2018 until 2026, interest on home equity loans and HELOCs is only tax deductible if the borrower uses the proceeds to buy, build, or substantially improve the home that secures the loan. For example, you can deduct the interest if you use the proceeds to build an addition onto your home, renovate your kitchen, or replace your roof.
There are also new limits to the amount of interest that a borrower is allowed to claim. Prior to 2018, borrowers could deduct the interest on up to $1 million of loans on a qualified residence.
In addition to their main residence, taxpayers can claim mortgage tax benefits on one additional second residence as long as they do not earn rental income from the second home.
Collateral In Your Home
It’s likely that your mortgage lender has a security interest in your home as collateral for repayment of the loan. This security interest generally allows the bank to remain on the title to your home. As long as the mortgage document you sign includes this type of security interest, then you may be eligible to deduct your interest payments.
When checking your mortgage document, it may either expressly state this or will provide that in the event you default on mortgage payments, the bank can foreclose on your home and apply all sale proceeds to the outstanding mortgage balance. However, if you use a credit card to subsidize the purchase of your home, these interest payments are not deductible since the credit card company doesn’t have any security interest in your home.
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What You Need To Know If Deducting Home Equity Loan Home Equity Lines Of Credit Or Second Mortgage Interest
You can only deduct interest payments on principal loans of up to $750,000 if married but filing jointly and $375,000 if youre filing independently if you bought a home after December 15th, 2017.
You can continue to deduct based on the limits in place before the TCJA if you purchased a property before that date.
To figure out how much you can deduct, you should add up the total loan amounts on the different loans outlined above. If it doesnt go above the described limits, you can deduct the total amount of interest. If the figure does exceed this limit, you can only deduct a portion of this interest.
Loans that qualify are those secured against a first or second home. Anything else doesnt count.
You must use the loan to perform substantial renovations. Any loans taken out before the TCJA must still follow the current qualification rules. So, if you deduct interest on loans used to pay for things like tuition or medical expenses in the past, you cant take that same deduction this year, so be prepared for that.
Other Benefits Of A Heloc
HELOC rates are only slightly higher than first mortgage rates, making HELOCs much less expensive than other loan options. Taking a HELOC also means that you only borrow as much as you neednot a lump sum, as is the case with a home equity loan. Sometimes, a HELOC features an option to lock in a fixed interest rate to repay the outstanding balance.
As a homeowner, you may borrow up to a specified amount based on the combined loan-to-value ratio. That includes the outstanding balance from a first mortgage plus the additional requested funds.
Generally, the CLTV ratio for a HELOC can exceed 80% for borrowers with strong . If you select one of these loans, then any interest on a balance that exceeds the homes value is not tax deductible. Higher-LTV loans charge bigger fees and put you at greater risk of going underwater on your loans should real estate values drop.
Getting a HELOC when one is available also makes more cash accessible in an emergency. Interest on a HELOC only applies when homeowners use the money, so the cost of getting one is relatively low. Therefore, it can be a good move to get one if you think that you might lose your job. If you wait until after a job loss, then you might not have sufficiently good credit to get a HELOC. Furthermore, banks can raise credit standards for HELOCs when an economic downturn, such as the coronavirus recession, occurs.
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Home Equity Loans Basics
Home equity loans use equity in the borrowers home as collateral. Taking out a home equity loan therefore means putting the borrowers home at risk. If the borrower fails to pay back the loan, the lender can foreclose and sell the home to pay off the debt.
Home equity loans generally carry lower interest rates than other loans, such as unsecured personal loans, but may involve higher fees and other costs. And they are only available to homeowners who have enough equity in their homes to meet lenders loan-to-value requirements. LTV benchmarks typically limit loans to 80%A fin of the homes appraised value.
Regular home equity loans advance the borrower a single lump sum of cash. Home equity lines of credit let borrowers take cash whenever they want to up to the amount of the loan. HELOC borrowers only pay interest on funds actually advanced.
Interest On Home Equity Loans Deductible In Some Cases
On February 21, 2018, the IRS issued a special advisory to explain that, in many cases, taxpayers can continue to deduct interest paid on home equity loans. The fact that they even issued this advisory indicates the widespread confusion over the subject. In fact, they mentioned it directly:
Responding to many questions received from taxpayers and tax professionals, the IRS said that despite newly-enacted restrictions on home mortgages, taxpayers can often still deduct interest on a home equity loan, home equity line of credit or second mortgage, regardless of how the loan is labelled.
- Basically, if youre using the money received to build out or improve the property, the interest you pay on the equity loan should be tax-deductible.
- But if youre using the money for other expenses , the tax deduction is no longer allowed.
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Other Benefits Of Home Equity Loans And Helocs
Being able to deduct the interest paid on a home equity loan or HELOC is just one of the benefits associated with these types of loans. Some of the additional benefits include:
- Favorable interest rates. These loans typically offer lower interest rates than unsecured debt, such as credit cards or personal loans.
- Long repayment terms. The repayment terms on HELOCs and home equity loans range from 10 years to as long as 30 years.
- Home equity loans and HELOCs can be a quick and easy way to access a large sum of money to pay for major expenses.
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Can I Get A Home Equity Loan Tax Deduction
The answer is you can still deduct home equity loan interest. But the rules have changed, and there are more limitations than ever before.
Interest on home equity loans has traditionally been fully tax-deductible. But with the tax reform brought on by President Trumps Tax Cuts and Jobs Act , a lot of homeowners are struggling to work out whether they can still take a home equity loan tax deduction.
This is now the first year the new rules will apply to their new taxes, despite the original act being passed in 2017.
The new law states that you can deduct interest related to your mortgage up to a limit of $750,000 on qualified loans for married couples who decide to file jointly. For individual filers, this limit is set at $375,000.
These new limitations apply up to the 2025 tax year.
The deduction applies to interest paid on home equity loans, mortgages, mortgage refinancing, and home equity lines of credit.
Suppose you took on the debt before December 15th. 2017. In that case, the home equity loan deduction could be taken on up to a million dollars worth of qualified loans for married couples filing jointly and half that amount for single filers.
Does Heloc Interest Tax Deduction Work The Same Way
While home equity loans and home equity lines of credit are two different products, their interest rate deductions rules are the same. If youre not sure the difference between the two, you can learn more about HELOCs here, but heres the gist:
A home equity loan allows you to borrow a lump sump over a set period of time with a fixed interest rate, while HELOCs are a little more flexible. With a line of credit, you can access the funds on that line of credit at any time during the established draw period . The HELOC also offers variable interest rates that follow market rates, unlike a fixed-rate home equity loan.
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Should I Get A Home Equity Line Of Credit Or A Home Equity Loan For The Tax Deduction
If you need a large amount of cash specifically to fund an improvement or repair on your primary residence, and if you are already itemizing your deductions, then a home equity line of credit or a home equity loan is probably an economically sound choice. If you are on the fence about a property remodel, then borrowing against your home just to take advantage of deducting the interest is probably not the best choice for you.
New Dollar Limit On Total Qualified Residence Loan Balance
For anyone considering taking out a mortgage, the new law imposes a lower dollar limit on mortgages qualifying for the home mortgage interest deduction. Beginning in 2018, taxpayers may only deduct interest on $750,000 of qualified residence loans. The limit is $375,000 for a married taxpayer filing a separate return. These are down from the prior limits of $1 million, or $500,000 for a married taxpayer filing a separate return. The limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayers main home and second home.
The following examples illustrate these points.
Example 1: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000. In February 2018, the taxpayer takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total does not exceed the cost of the home. Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible. However, if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan would not be deductible.
For more information about the new tax law, visit the Tax Reform page on IRS.gov.
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Can You Deduct Home Equity Loan Interest From Your Taxes
You can use home equity loans and lines of credit to make improvements such as adding a new roof, consolidating debt or completely remodeling a kitchen or bathroom. The difference between the amount owed on an existing mortgage and a home’s market value is considered available equity and serves as collateral for home equity loans. Many homeowners favor these types of loans over other debt because the interest is usually tax-deductible, with certain restrictions defined by the Internal Revenue Service .
Is Interest On A Home Equity Line Of Credit Tax Deductible
Lea Uradu, J.D. is graduate of the University of Maryland School of Law, a Maryland State Registered Tax Preparer, State Certified Notary Public, Certified VITA Tax Preparer, IRS Annual Filing Season Program Participant, Tax Writer, and Founder of L.A.W. Tax Resolution Services. Lea has worked with hundreds of federal individual and expat tax clients.
If you need cash and have equity in your home, a home equity loan or home equity line of credit can be an excellent solution. But the tax aspects of either option are more complicated than they used to be. Interest on a HELOC may be tax deductiblebut there are conditions.
There are two types of home equity lending: a fixed-rate loan for a specified amount of money, or a variable-rate line of credit . Depending on your need for the funds and how you plan to use them, one option may work better than the other. Interest paid on either loan, like the interest on your first mortgage, is sometimes tax deductible.
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What You Should Expect When Filing Taxes
The standard deduction will have risen slightly by the time you file your taxes. The standard deduction will be $24,400 for married couples filing jointly and $12,200 for taxpayers filing as individuals.
The AMT exemption will be $71,700 for individuals, with a gradual phaseout at $510,300. Married couples filing jointly will see their exemption raised to $111,700, with a phaseout limit of $1,020,600.
There will also be other changes for taxpayers.
For example, the maximum credit for expenses relating to adoption will be raised to $14,080. Also, taxpayers not enrolling in a health insurance program wont have to pay a penalty for not doing so.
Make sure you stay alert as to any tax changes because 2019 will be a landmark year. Many of the provisions set out by the TCJA will be coming into effect for the first time this coming tax filing season.
Reporting Interest Deductions On Your Taxes
Homeowners wishing to capitalize on second mortgage interest tax deductions will need to maintain documentation pertaining to any related transactions. Likewise, per IRS guidelines, theyll also need to submit a 1098 Form provided by their lender alongside a Form 1040, Schedule A for itemized deductions. A qualified tax accountant can help you compile and get this paperwork in order.
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