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.
Benefits Of Home Improvement
Home improvement projects, which often qualify as substantial improvements, can potentially help you reduce your taxable income. But you get more than tax benefits, including:
Increased value Renovations typically add to your home’s value. A smart way to borrow against home equity is to reinvest in your home. Doing so allows you to potentially sell your house at a higher price, providing funds to pay off debts or put toward your next property.
Better quality of lifeYou can also make your home more comfortable to live in, more efficient, and more useful for your needs. Financial benefits are always nice, but spending time in a home you enjoy is also a worthy goal.
How the deduction worksTo qualify for a deduction under current law, you must meet specific criteria. Speak with a tax professional to verify your eligibility before claiming a deduction.
Substantial improvementsYou must use the proceeds of a home equity loan to buy, build, or substantially improve your home. Since you already own a home, you would presumably use funds to renovate your property.
Dollar limitsYou can deduct interest on a maximum of $1,000,000 of home equity loan debt, if you purchased your home before 2017 and are married and filing jointly. If you purchased your home after the maximum amount is lower, $750,000including your purchase loan. Although you can borrow more than that, your ability to deduct will be limited.
Here are some basic examples to illustrate.
Think About Using Online Tax Preparation And Filing
Tax can be confusing. It can be complicated, and you need to know that youre taking every deduction you can. For this reason, you should consider using online tax preparation.
The online software will help you claim the home equity tax credits and deductions youre eligible for. Theyll also be able to help you decide whether you should itemize your deductions or take the standard deduction.
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Get Your 1098 From Your Lender Or Mortgage Servicer
To fill out the information about the interest you paid for the tax year, youll need a 1098 Form from your mortgage lender or mortgage servicer, the entity you make your payments to. This document details how much you paid in mortgage interest and points during the past year. Its the proof youll need for your mortgage interest deduction.
Your lender or mortgage servicer will provide the form for you at the beginning of the year, before your taxes are due. If you dont receive it by mid-February, have questions not covered in our 1098 FAQ or need help reading your form, contact your lender.
Keep in mind, you will only get a 1098 Form if you paid more than $600 in mortgage interest. If you paid less than $600 in mortgage interest, you can still deduct it.
Best Practices For Claiming The Home Equity Interest Deduction
If you own a home and are planning to claim the home equity loan interest deduction, there are a few things to remember.
First, the money must be used for home improvements or renovations. You cannot take the deduction if you are using home equity proceeds to pay for personal expenditures or to consolidate credit card debt, for example. The same goes if you are taking out a loan and letting the money sit in the bank as your just-in-case fund for emergencies.
What’s more, the renovations have to be made on the property on which you are taking out the home equity loan. You cannot, for example, take out a loan on your primary residence and use the money to renovate your cottage at the lake.
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Borrowing To Earn Income
The Interest you pay on money you borrow to earn investment income that pays out interests and dividends are deductible in Line 22100 of your Income Tax and Benefit Return. If you are paying interest on money borrowed to generate business income, then you can deduct them as business expenses in Line 8760 of your T2125 .
Interests paid on a mortgage cannot be deducted unless this mortgage is paid on a property that is used for business. Then you will be able to deduct the business use portion only.
Rules For Home Equity Loan Interest Tax Deduction
To claim a deduction on your taxes, you must be able to prove how you spent your home equity loan. So hang onto invoices, receipts, bank statements, or other records detailing payments to contractors or purchased materials.
As long as you can trace the funds to a specific qualified purchase, which would be an improvement to a qualified residence, then you can deduct the interest, says Nathan Rigney, JD, principal tax research analyst at The Tax Institute at H& R Block.
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How To Claim A Home Equity Loan Interest Deduction
If you want to claim the interest deduction for your home equity loan, youll have to itemize your deductions. An itemized deduction is an expense that reduces your adjusted gross income, lowering your overall tax bill.
The majority of taxpayers, however, take the standard deduction instead. The standard deduction is $24,800 for a married couple and $12,400 for an individual, according to the IRS. Since the standard deduction was raised as part of The Tax Cuts and Jobs Act of 2017, the number of taxpayers who itemize has fallen by 17 percentage points, according to the Tax Foundation.
In order to claim deductions on home equity loan interest, your total itemized deductions which includes mortgage interest as well as charitable donations, state and local taxes, and other qualifying expenses must be more than standard deduction.
A lot of people think, I have a mortgage, and I can use the interest as a deduction on my tax return. But you have to exceed that amount of standard deduction to be able to do that, say Karl Schwartz, CPA, certified financial planner, and principal and senior financial adviser at Team Hewins, a financial planning and investment firm. If they dont have much in other deductions, then they may not be able to use any of .
Is Interest On My Home Equity Loan Tax Deductible
Whether or not you can deduct the interest paid on your home equity loan depends on when you took out your loan, how much you borrowed and what you used the funds for.
With the passage of the Tax Cuts and Jobs Act of 2017, joint filers who took out their home equity loan after Dec. 15, 2017, can deduct interest on up to $750,000 worth of qualified loans, while separate filers can deduct the interest on up to $375,000. However, the funds from the loan must be used to buy, build or substantially improve the home that was used to secure the loan. This means that you can no longer deduct the interest on home equity loans that you use to pay off debt or put toward an emergency expense.
Those limits also include any mortgage loans currently outstanding. For example, if you still have a mortgage balance of $500,000, only $250,000 of home equity loans will be eligible for tax deductions.
If you took out your home equity loan prior to Dec. 15, 2017, your limits are higher at $1 million for joint filers and $500,000 for separate filers, as long as the funds were used to buy, build or improve the home.
If you have a home equity loan, heres how to tell whether you can deduct the interest.
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What Tax Forms Do You Need From Your Lender
- Mortgage Interest Statement Form . Provided by your home equity loan lender, showing the total amount of interest paid during the previous tax year. If you dont receive this form from your lender, you should contact them.
- Statement for additional paid interest. This is only applicable if you paid more home equity loan interest than whats shown on your Form 1098. Youll need to write the additional interest amount paid, explain the discrepancy, and provide this statement with your tax return.
- Proof of how home equity funds were used. These receipts and invoices will show expenses that significantly improved the value, durability, or adaptiveness of your home including costs for materials, labor fees, and home improvement permits.
Here are some other things to consider as you assemble any documents you might need:
- Make a folder to save all your receipts and records for home improvements.
- If youve lived in your house for many years and area housing prices have been going up, a portion of your gain on sale could be taxable. If so, you can reduce the taxable gain by including the improvements in the cost basis of the house.
- If you operate a business from your home or rent a portion of your home out to someone, you may be able to write off part of your homes adjusted basis through depreciation.
To deduct interest from loan payments, youll need to itemize the deductions using a the IRS Form 1040 or 1040-sr.
Other Provisions Of The Act Regarding Interest Deductibility
1.100 In addition to the legislation discussed in this Chapter, other provisions of the Act may also have application to the deduction of interest expense. A discussion of all of these provisions would be beyond the scope of this Chapter, but some are noted below for reference purposes:
- sections 15.1 and 15.2, interest on small business development bonds and small business bonds
- paragraph 18, payments on income bonds
- subsections 18 to , limit on certain interest and property tax
- subsections 18 to , limitation re: deduction of interest by certain corporations
- subsection 18, limitation respecting prepaid expenses
- subsections 18 to , penalties, bonuses and rate-reduction payments
- subsection 18, limitation
- subsection 18.3, interest on a liability of an entity that is a stapled security
- paragraph 20, repayment of interest
- subsection 20, accrued bond interest
- subsection 20, interest on debt obligation
- section 20.2, interest – authorized foreign bank
- section 20.3, weak currency debt
- section 21, cost of borrowed money
- section 67.2, interest on money borrowed for passenger vehicle
- subsection 138, deductions not allowed and
- subsection 144.1, interest payable by employer re: employee life and health trust.
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Maximum Allowances For Mortgage Loan Interest Deductions
Previously, home equity deductions were separate from whatever you claimed on your first mortgage. Beginning 2018, married couples filing jointly can only deduct home loan interest up to a new maximum allowance of $750,000 .
Probably the biggest change in the tax code has to do with home equity
If you have been deducting interest on debt over $750,000 and your loan came about on or before December 15, 2017, grandfathering rules can apply. Contact your tax professional about the specific details of your situation to determine how much debt qualifies for the interest deduction.
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Interest Rates And Fees If You Refinance Your Home
The interest rate on the refinanced part of your mortgage may be different from the interest rate on your original mortgage. You may also have to pay a new mortgage loan insurance premium.
You may have to pay administrative fees which include:
- appraisal fees
Your lender may have to change the terms of your original mortgage agreement.
What Qualifies As Mortgage Interest
There are a few payments you make that may count as mortgage interest. Here are several you may consider deducting:
Interest on the mortgage for your main home: This property can be a house, co-op, apartment, condo, mobile home, houseboat or similar property. However, the property will not qualify if it doesnt have basic living accommodations, including sleeping, cooking and bathroom facilities. The property must also be listed as collateral for the loan youre deducting interest payments from. You can also use this deduction if you got a mortgage to buy out an exs half of the property in a divorce.
You can still deduct mortgage interest if you receive a non-taxable housing allowance from the military or through a ministry or if you have received assistance under a State Housing Finance Agency Hardest Hit Fund, an Emergency Homeowners Loan Program or other assistance programs. However, you can only deduct the interest you pay. You cannot deduct any interest that another entity pays for you.
Interest on the mortgage for a second home: You can use this tax deduction on a mortgage for a home that is not your primary residence as long as the second home is listed as collateral for that mortgage. If you rent out your second home, there is another caveat. You must live in the home for more than 14 days or more than 10% of the days you rent it out whichever is longer. If you have more than one second home, you can only deduct the interest for one.
Get approved to refinance.
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Guidelines For Home Equity Loan Tax Deductions
The standard rule is that a couple can deduct the interest paid on up to $100,000 in home equity loan debt and a single filer can deduct the interest on up to $50,000. So if a couple has a $100,000 home equity loan and paid $7,000 in interest on it over the course of the year, they can take a $7,000 deduction on their joint tax return.
That’s going to cover most home equity borrowers. But there’s an added wrinkle that can raise those limits depending on how you use the money.
The IRS allows couples filing jointly to deduct the interest on home loans for up to $1 million in home acquisition debt, and up to $500,000 for single filers. Most of the time, that’s going to be the deduction for the primary mortgage used to purchase the home.
However, the IRS defines home acquisition debt as debt used to “buy, build or improve” a home. So if you take out a home equity loan and use it for home repairs or improvements, it’s considered home acquisition debt and subject to the higher $1 million/$500,000 limits.
So if a single filer were to take out a $75,000 HELOC and use it to build an addition onto his home, he could deduct the home equity loan interest paid on the entire $75,000. But if he were to use it to buy a boat or pay for his daughter’s college expenses, he could only deduct the interest paid on the first $50,000 of the amount.
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.
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Which Interest Is Still Deductible Despite The Tax Cuts And Jobs Act
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.
The Tax Cuts and Jobs Act of 2017 introduced a slew of new tax breaks while doing away with several others. Some of the tax changes directly affected taxpayers who own a home or plan to purchase one.
The changes include a reduction of the cap on the mortgage interest deduction. The deduction can be claimed only for the interest paid on mortgage debt up to $750,000 if the loan was taken out after Dec. 15, 2017. The previous limit was $1 million. For example, if you have a mortgage for $800,000, you cannot deduct the interest paid on $50,000 of that loan.
In addition, going forward theres a cap of $10,000 on itemized deductions for state and local taxes , including property taxes. One of the eliminated measures affects tax benefits for home equity loan interest. Much of that deduction was effectively eliminatedat least through the end of 2025.
The Internal Revenue Service , however, has left a loophole in the current tax law that would permit some homeowners to continue benefiting from the home equity loan interest deduction.
