The lockdowns of the past year have forced people to spend a lot more time at home, which inspired many home improvement projects. To finance these renovations, add-ons, or repairs, many homeowners took out home equity loans.
Now that it’s tax time, and you may be wondering: Is the interest on those home equity loans tax deductible? The short answer is yes — but it depends on several factors, and only taxpayers who itemize will be able to take advantage.
A home equity loan lets you borrow against the value of your home, using the equity you’ve accumulated as collateral. More than 30% of American homeowners are considered “equity rich,” which means the total amount of their home loans is 50% or less of the estimated value of their home, according to ATTOM Data Solutions, a source of real estate data solutions.
Just don’t confuse a home equity loan with a home equity line of credit, or HELOC. A home equity loan gives homeowners one lump sum, while a HELOC offers a predetermined amount that you can access here and there to cover expenses.
If you’re ready to do your taxes, here are a few things to know about claiming the home equity loan interest tax deduction.
Is the Interest on My Home Equity Loan Tax Deductible?
Whether your home equity loan interest is tax deductible depends on two factors: whether you spent the money to make substantial improvements on a qualified residence — meaning your first or second home — and the total amount of your mortgage debt.
“If you use it to expand your kitchen or add a deck or make some type of improvement to your home, that’s when it’s going to be tax deductible,” says Thomas Castelli, CPA and partner at The Real Estate CPA in Raleigh, North Carolina. “Say you take out a home equity loan against that primary residence and use it to go to Turks and Caicos. That’s not going to be deductible.”
For any mortgage taken out after December 16, 2017, you can only deduct interest on loans — including a combination of the primary mortgage and home equity loans — up to $750,000. The limit is $1 million for mortgages taken out before that date.
If the debt on your home exceeds these amounts, you could only deduct part of the interest, Castelli explains. In these cases, it’s a good idea to talk to an accountant to help you figure out what your interest deduction would be.
How to Claim a Home Equity Loan Interest Deduction
If you want to claim the interest deduction for your home equity loan, you’ll 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 don’t have much in other deductions, then they may not be able to use any of [the home equity loan interest].”
What Home Equity Loan Interest Is Tax Deductible?
All of the interest on your home equity loan is deductible as long as your total mortgage debt is $750,000 (or $1 million) or less, you itemize your deductions, and, according to the IRS, you use the loan to “buy, build or substantially improve” your home.
The IRS hasn’t defined what exactly that includes. “It’s basically to make capital improvements on your principal or secondary residence,” says Castelli. “Anything that’s going to improve the value of your home is going to be considered a capital improvement, for the most part.”
For example, interest on your home equity loan would likely be deductible if you spend the funds on replacing a roof or siding, adding on a room, remodeling the kitchen, or even installing a pool.
Any home improvement project paid for with your home equity loan must be made on the home securing the loan.
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.
What Forms Do You Need for This Interest Tax Deduction?
Your lender should send you a Form 1098, a Mortgage Interest Statement, by the end of January each year.
“It’ll tell you how much interest you paid during the year, and then it gives you other information, too, like the balance of the loan,” Schwartz explains.
Only interest of $600 or more is reported on this form. If your interest is less than that, you might not receive a 1098. But you can still report the interest on your tax return.
Only taxpayers who itemize their deductions can claim the interest deduction on their home equity loan. The interest, combined with other deductions, would have to be more than $12,400 for a single person.
The Bottom Line
A home equity loan is a great way to pay for repairs and upgrades that will create a much more enjoyable living space and even add to the value of your home. But several factors influence whether or not you can deduct the interest on the loan. It depends on how you spend the money, how much debt you have on your home, and how many other tax deductions you have.