Home Equity Loans Can Be Tax Deductible — Depending on How You Use Them

In the wake of the COVID-19 pandemic, more people spend more time at their homes. This has led to a number of home improvements. Many homeowners used home equity loans to finance their renovations, repairs, and add-ons.

All these changes could have an impact on your taxes. Is the interest paid on home equity loans tax-deductible? It depends on many factors and taxpayers who itemize are eligible to benefit.

You can borrow against your home’s value using equity you have accumulated as collateral in a home equity loan tax deduction. According to ATOM Data Solutions (a source of real-estate data solutions), nearly 45% of American homeowners consider themselves “equity wealthy.” This means that their total home loan amount is less than 50% of their home’s estimated value.

Don’t confuse a home-equity loan with a line of credit or HELOC. A home equity loan provides homeowners a lump sum while a HELOC allows you to access a predetermined amount whenever you need it.

Here are some tips to help you claim the tax deduction for home equity loan interest when it comes time to file your taxes.

Can I deduct the interest on my home equity loan?

The tax deductibility of home equity loan interest depends on two factors. Whether you used the money to make significant improvements on a qualified residence (i.e. your first or second home) and the total amount of your mortgage debt.

“If you use it for an expansion of your kitchen, deck, or other improvement to your home, it will be tax-deductible,” states Thomas Castelli. He is a CPA and partner at The Real Estate CPA, Raleigh, North Carolina. Let’s say you take out a loan on your primary residence to pay for Turks and Caicos. It’s not deductible.

You can deduct interest only on loans up to $750,000 for mortgage that were taken out after December 16, 2017. For mortgages that were taken out prior to December 16, 2017, the limit is $1,000,000

Castelli says that if your debt exceeds these amounts you can only deduct part or all of the interest. It’s a good idea for these cases to speak to an accountant so they can help you determine your interest deduction.

How to Claim an Interest Deduction on a Home Equity Loan

You will need to list your deductions if you want to claim interest deductions for your home equity loan. An itemized deduction refers to an expense that lowers your adjusted gross income and lowers your overall tax bill.

However, the majority of taxpayers opt for the standard deduction. According to the IRS, the standard deduction for married couples is $25,900 and for individuals, $12,950 in tax year 2022.

To be eligible for deductions on home equity loan interests, your total itemized deductions must exceed the standard deduction. This includes mortgage interest as also as charitable donations, state or local taxes, and any other qualifying expenses.

“Many people believe that if they have a mortgage, they can deduct the interest on their tax returns.” Karl Schwartz is a CPA, certified financial advisor, principal and senior financial advisor at Team Hewins. Team Hewins is a financial planning and investing firm. “If they don’t have enough in other deductions, they might not be able [to use the home equity loan interest].

Is Home Equity Loan Interest Tax Deductible?

You can deduct all interest on your home equity loan as long as you have less than $750,000 in total mortgage debt.

The IRS doesn’t define exactly what that means. Castelli says that it is basically to make capital improvement on your principal or second residence. Capital improvements are anything that will increase the value of your house.

If you use the money to replace a roof, siding, add on a room, remodel the kitchen or install a pool, the interest on your home equity loan is likely to be deductible.

All home improvements that are paid for by your home equity loan must be done on the property securing the loan.

Home Equity Loan Interest Tax Deduction

You must prove that you have used your home equity loan in order to claim a tax deduction. Keep receipts, bank statements, and other documents detailing payments to contractors or purchases, such as invoices, receipts, or receipts.

“As long you can trace the funds back to a qualified purchase (which would be an improvement on a qualified residence), then you can deduct interest,” states Nathan Rigney principal tax research analyst at The Tax Institute of H&R Block.

What forms are required for this interest tax deduction?

Each year, your lender must send you a form 1098, a mortgage interest statement, before the end of January.

Schwartz explained that the tool will tell you how much interest was paid over the year and give you additional information such as the balance of your loan.

This form reports only interest exceeding $600. You might not be eligible for a 1098 if your interest is lower than $600 However, you can still report interest on your tax returns

PRO TIP

Only taxpayers who have itemized their deductions are eligible to claim the interest deduction for their home equity loan. A single person would need to pay more than $12,950 in interest and other deductions.For more details to visit website americantaxservice.org

The Bottom Line

Home equity loans are a great way for you to finance home improvements and repairs that will make your home more comfortable and increase the value. There are many factors that can influence your ability to deduct interest from the loan. It all depends on how much you spend, how much you owe on your home, as well as how many tax deductions you have.

 

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