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Home equity is a powerful financial tool, and for many homeowners, a home equity line of credit (HELOC) can finance home improvements or consolidate debt.
But did you know a HELOC can also create tax benefits?
When used strategically, the interest paid on your HELOC may be tax deductible, saving you money and lowering your overall tax burden.
What type of home loans are tax deductible?
Mortgage interest on a primary mortgage, the type of loan used to buy a home, can be tax deductible for most home buyers.
Mortgage interest paid on a home equity loans or home equity line of credit (HELOC) may also be tax deductible, depending on how the homeowner uses the loan.
To qualify for a tax deduction, the loan must be secured by your home and the funds must be used for qualified home improvements, such as remodeling your kitchen or adding an extension.
How is HELOC interest tax deductible?
The IRS allows homeowners to deduct interest paid on HELOCs, but specific conditions must be met. As we mentioned above, the HELOC funds must be used to pay for home improvements like a kitchen remodel or a new roof.
If the homeowner uses money from a HELOC to buy a car or go on a vacation, the interest paid will not be tax deductible.
To claim the mortgage interest tax deduction from a HELOC, the homeowner must itemize tax deductions. Tax payers who claim the standard deduction won't have a chance to write off HELOC interest no matter how they spend the money.
What qualifies as "qualified home improvements" for a tax deduction?
Projects that add value to your property, such as remodeling your kitchen, updating bathrooms, or replacing the roof qualify as "qualified home improvements" with the IRS.
Maintenance repairs, like fixing a leaking roof or replacing the hot water heater, do not qualify.Â
How can tax deductions on home equity loans help homeowners?
By deducting the interest paid on a HELOC, you can lower your taxable income for the year. This can, in turn, lower your annual income tax bill.
Even if you don’t qualify for a tax deduction, a HELOC can still be a valuable financial tool. Compared to credit cards or personal loans, HELOCs can offer lower interest rates and more flexible repayment terms.
If you’re weighing the benefits of a HELOC versus other options, check out this comparison of a home equity line of credit vs home equity loan to decide which option works best for you.
HELOC vs. home equity loan: What’s tax deductible?
While both home equity loans and home equity lines of credit can access cash from home equity, these loan products have a key difference:
– A home equity loan offers a lump sum payment with fixed interest rates.
– A home equity line of credit (HELOC) offers more flexible access to funds with variable interest rates.Â
But deducting interest paid on either loan still depends on how the homeowner uses the cash.
If the HELOC or home equity loan is used for purposes other than home improvement or repairs, like paying off credit card debt or covering education expenses, the interest will not be tax deductible.
Mortgage interest from either loan type should be claimed on Schedule A (Form 1040) as itemized deductions.
Is a HELOC still worth it without deductible interest?
Even without the deduction, taking out a home equity line of credit (HELOC) or home equity loan can make financial sense. Since they're secured by your home, these loans can offer lower interest rates compared to credit cards or personal loans.
Homeowners often use HELOCs and home equity:
- Debt consolidation
- Education expenses
- Emergency funds
- Renovations and home upgrades
While you may not be able to deduct the interest, the potential savings from a HELOC’s lower interest rate, compared to credit cards or personal loans, can still make a major difference.
How to deduct and claim taxes with HELOC
If you're eligible to deduct the interest paid on your HELOC, follow these steps to ensure you claim it correctly:
1. Decide if claiming the tax deduction is worth it
To claim a HELOC interest deduction, you need to itemize your deductions on your tax return. This means forgoing the standard deduction, so it’s important to know whether itemizing will create more savings than the standard deduction.
Working with a tax professional can help you make that determination. Your tax professional can help you compare your total eligible deductions (including HELOC interest) with the standard deduction to determine the most beneficial approach.Â
2. Collect all necessary paperwork
Gather the documents needed to claim the deduction:
- IRS Form 1098 from your lender, which outlines the interest you paid on your HELOC. Also, your monthly HELOC statements will provide a detailed breakdown of the total interest paid during the tax year.
- Receipts and invoices proving that HELOC funds were spent on qualified home improvements.
3. Calculate the total deduction
Determine how much of your HELOC’s interest qualifies for deduction by considering:
- The total amount of interest paid for the year.
- The proportion used for qualified home improvement expenses.
Use this information to accurately calculate the deductible amount while staying within the cap limits set by the IRS.
File your taxes and claim your deduction
When filing your tax return:
- Report the deductible interest on Schedule A (Form 1040), under the “Home Mortgage Interest” section.
- Include any supporting documents with your tax filing where required.
If you’re unsure about anything, it’s best to consult a tax professional to avoid errors or penalties.
Key benefits of HELOC tax deductions
A HELOC tax deduction offers multiple advantages for homeowners. Understanding how to use these opportunities can improve your overall financial health:
- Lower tax burden – By reducing your taxable income, you may owe less when April rolls around.
- Empowered financial planning – A HELOC allows for strategic investments in your property, boosting its long-term value while taking advantage of immediate tax savings.
- Accessible funding – HELOCs typically provide an affordable borrowing option compared to other loans, regardless of whether or not the interest is deductible.
Key rules for deducting HELOC interest
1. Funds must be used for home improvements
The Tax Cuts and Jobs Act of 2017 introduced a new rule for HELOCs to qualify for a tax deduction. The funds must be used solely for "qualified home improvements." This includes renovations or repairs that add value to your primary residence, such as remodeling your kitchen, replacing the roof, or building an addition.
Understanding the key HELOC requirements can help avoid issues when applying for a loan. Be sure to check out this resource on the essential HELOC requirements to ensure you’re prepared.
2. Home Equity Loan vs. HELOC
Both home equity loans and home equity lines borrow against your home's equity, and the interest deduction rules apply to both equally, as long as the funds are used for eligible home improvements.
Cash out refinances are another way to tap into home equity but work differently that home equity loans and HELOCs. Understanding the differences between home refinances and home equity loans will help you understand which option fits your needs.
3. Deduction limits apply
The IRS sets a cap on the mortgage debt that qualifies for interest deductions. Currently, this limit is $750,000 for married couples filing jointly and $375,000 for individual filers. This total includes your primary mortgage and any HELOC or home equity loan.
Unlock your home equity with Better
Navigating the details of HELOC tax deductions might seem complex, but the benefits are well worth it. With a HELOC, you gain not only financial flexibility but also the potential to save thousands of dollars in taxes.
If you’re thinking about getting a HELOC, why not make the process as smooth as possible? Better offers a simple, digital HELOC application with approval in as little as three minutes and the ability to get cash from your couch in as little as 7 days.
The Better platform ensures a seamless experience, helping you unlock your home’s equity fast and easily to achieve your financial goals.
....in as little as 3 minutes – no credit impact