Make the most of your home equity loan tax deductions. Discover how to save on taxes by understanding the ins and outs of interest deductibility.
Buying a home is just the beginning of homeownership and, more often than not, homeowners are taught to “expect the unexpected” when it comes to their property. Whether it’s repairing a broken thermostat or addressing water damage from the likes of termites or mold, homeownership definitely comes with its fair share of unexpected costs. Then there’s the matter of making your house the home that you want it to be. Be it adding another room or building a swimming pool, the cost is worth it when it makes you satisfied with your abode.
Now, unexpected or otherwise, home-related expenses need to be paid for. Among the most popular ways to do so is having the home pay for itself by way of a home equity loan. Also called a “second mortgage,” a home equity loan is a financial tool that allows a homeowner to leverage the equity in their home to borrow money from a lender. The money can then be used by the homeowner however they please, be it to improve their existing home, pay for other debts, or even buy another property.
When applying for these, a common question often arises: “Is a home equity loan interest tax deductible?"
So today, we will explore home equity loans in detail, and particularly dissect their tax deductibility, eligibility prerequisites, potential advantages, and some of the misconceptions surrounding them.
Before diving deep into tax deductibility, let us first understand why it is significant for homeowners.
Tax deductibility, a financial boon, is when specific expenses are subtracted from taxable income. This is done to help narrow down the portion of income subject to taxation. This translates into substantial savings, which makes it a common consideration for homeowners.
So this now continues to beg the question: Does the interest on a home equity loan merit tax deductibility?
The answer, as it often is regarding taxation matters, is not an absolute yes or an outright no. Several variables have to line up to determine whether the interest paid on a home equity loan can be claimed as a tax deduction.
Among the most important is the loan's purpose. Typically, interest on loans used for home improvements or home acquisition, construction, or substantial enhancements is considered tax deductible.
The landscape of tax deductibility for home equity loan interest isn't monolithic; rather, it shifts based on the specific type of loan in your possession. The rules can vary depending on the type of loan, the amount of the loan, and how the loan proceeds are used. In general, however, the following rules apply:
Interest on HELOCs can only be deducted if the loan proceeds are used for the improvement of the borrower's home. This includes repairs, renovations, and additions.
The maximum HELOC interest tax deduction that can be made is $750,000 for married couples filing jointly, or $375,000 for singles or married couples filing separately.1
Interest on fixed-rate home equity loans is only deductible if the loan proceeds are used to improve the borrower's home or to buy a new home.
The maximum amount of interest that can be deducted is also $750,000 for married couples filing jointly, or $375,000 for singles or married couples filing separately.
It’s important to note that these are just general rules, and there may be exceptions. For example, if the borrower uses the home equity loan to pay off debt, the interest may still be deductible if the debt was incurred to pay for home improvements.
Here are some additional things to keep in mind about the tax deductibility of interest on home equity loans:
If you are considering taking out a home equity loan, consult with a tax specialist to determine if the interest on the loan will be deductible.
See related: Can You Refinance a Home Equity Loan?
Eligibility for tax deductions on a home equity loan depends on the satisfaction of specific criteria.
The maximum amount of interest that can be deducted is $750,000 for married couples filing jointly, or $375,000 for singles or married couples filing separately. This limit applies to the total amount of home equity debt that the borrower has outstanding, not just the amount of interest that is paid in a given year.
For example, if a married couple has a home equity loan of $500,000 and they pay $10,000 in interest in a year, they can only deduct $7,500 of that interest, because the total amount of their home equity debt exceeds the $750,000 limit.3
The interest deduction is subject to phase-out if the borrower's adjusted gross income (AGI) exceeds certain thresholds. For married couples filing jointly, the phase-out begins at $109,000 of AGI and is complete at $119,000 of AGI. For singles, the phase-out begins at $54,500 of AGI and is complete at $59,500 of AGI.
Here is an illustrative scenario to help you understand the eligibility and limitations of the home equity loan interest deduction:
In this scenario, you can deduct the interest on your home equity loan because:
The maximum amount of interest that you can deduct is $7,500 because the total amount of your home equity debt does not exceed the $750,000 limit.
The legal landscape of taxation remains ever-evolving, inevitably impacting how tax-deductible home equity loan interest is. Staying abreast of recent legislative changes is important in understanding the scope of your ability to claim this deduction. By working with a real estate tax specialist, you can ensure you are up-to-date and make informed decisions.
The tax-deductible nature of home equity loan interest undoubtedly makes home equity loans an attractive source of income. With minimized interest payments, it allows for more funding that can then be allocated for the fulfillment of other financial needs, be it debt consolidation, a second mortgage, or other future investments.4
Yet, just as it is with making any financial decision, one should not enter into a home equity loan haphazardly. Taking stock of your financial standing remains paramount, and seeking professional financial advice can help better determine if a home equity loan is indeed something your overall finances can readily accommodate.
When it comes to home equity loan interest tax deductibility, there are a few common misconceptions that can cloud clarity. Here are a few of the most common:
It’s helpful to understand these misconceptions so that you can make informed decisions about whether or not to take out a home equity loan. Before getting into home equity indebtedness, it’s a good idea to talk to a tax specialist to make sure that you understand the tax implications.
The taxes (or, in this case, the possible deduction of them) are the distinct advantage that home equity loans have over other types of loans. The interest in credit card loans and personal loans rarely garner tax deductions, making home equity loans a viable option when in need of funding and, of course, borrowing as a homeowner.
Indeed, a home equity loan can be a versatile tool for homeowners. It not only allows you to access funds for a variety of purposes but also enjoys the benefit of having interest on the loan potentially being tax-deductible, which ultimately saves you money. However, it's important to understand the tax rules and eligibility requirements for home equity loans before taking one out.
Truehold's sale-leaseback lets you tap into your home equity without the risks of a loan. With a sale-leaseback, you sell your home to Truehold and then lease it back from us, while enjoying the benefit of:
If you're considering accessing the equity in your home, Truehold's sale-leaseback is a great option to consider. Contact us to learn more.
Sources:
1. Investopedia. Is Interest on a Home Equity Line of Credit (HELOC) Tax Deductible? https://www.investopedia.com/mortgage/heloc/tax-deductible/
2. Internal Revenue Service. Home Mortgage Interest Deduction. https://www.irs.gov/publications/p936
3. Time. Are Home Equity Loans Tax Deductible? https://time.com/personal-finance/article/are-home-equity-loans-tax-deductible/
4. Bank Rate. Are home equity loans tax-deductible? https://www.bankrate.com/home-equity/home-equity-loan-tax-changes/
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