Is Home Equity Loan Interest Tax Deductible?
- Under the Tax Cuts and Jobs Act of 2017, home equity loan interest is still tax-deductible for many Americans.
- Your ability to deduct home equity loan interest depends on how much you borrow and how you use the funds.
- You must itemize your deductions to claim a home equity loan interest deduction.
Many American homeowners mistakenly believe that home equity loan interest is no longer tax-deductible. However, you may be able to take advantage of this deduction if you qualify. Your deduction depends on how you use the money, how you use the property, and how much total mortgage debt you have.
What Is the Tax Cuts and Jobs Act of 2017?
The Tax Cuts and Jobs Act of 2017 reformed the individual income and corporate tax codes. Some of the key changes instituted by the Act affecting individual taxpayers include:
- A reduction of the top marginal tax rate from 39.6% to 37%
- Elimination of personal exemptions
- Substantial increases to standard deductions
- Expansion of the Child Tax Credit
- Increases to the estate tax exemption
- Caps on state and local tax (SALT) deductions
- Caps on mortgage interest deductions, including interest paid on home equity loans
While the Tax Cuts and Jobs Act included some permanent changes to the tax code for businesses, many of the provisions for individual taxpayers are set to expire after 2025.
So, is home equity loan interest tax-deductible in 2021 and beyond? The short answer is, it depends.
When Can You Deduct Home Equity Loan Interest?
The Tax Cuts and Jobs Act of 2017 did not eliminate homeowners' ability to deduct interest on home equity loans. However, the Act did impose restrictions on tax-deductible home equity loan interest.
For home equity loan interest to be tax-deductible, three conditions must be met:
- Loan limits
- How the loan is secured
- Loan use
It's essential to understand what the IRS requires for all three before taking out a home equity loan if you're hoping to deduct the interest later.
The Tax Cuts and Jobs Act established a new dollar limit on mortgage debt for interest deductions. For new mortgage loans and home equity loans taken out January 1, 2018 or later, the cap is $750,000 ($375,000 if you file single or are married and file separate returns.) The previous limit was $1 million for married couples filing a joint return and $500,000 for single filers and married couples filing separately.
What happens if total mortgage balances on a first and second loan exceed the limit allowed by the IRS? You benefit more by deducting the mortgage interest for the mortgage with a higher interest rate. (This is usually the home equity loan.) You can then write off some of the interest on the other loan.
It's important to note that loan amounts cannot exceed the cost of the home when deducting loan interest. Significantly, the IRS does not say “property value” in this section. The rule specifies that the total loans cannot exceed the home’s cost.
The second component of eligibility for a tax deduction is property use. The IRS requires the loan to be secured by a first or second home. Your first home is your primary residence – where you live most of the time.
A second home is a property you treat as a vacation home. To qualify for home equity interest deduction as a second home, you use the property for at least 14 days or 10% of the days you rent it to others, whichever is greater. If you treat the property mainly as a rental, you can fully deduct home equity interest (see below).
The IRS has clear limitations concerning when you can (and can’t) deduct mortgage interest. The Tax Cuts and Jobs Act only allows homeowners to deduct home equity loan interest (or HELOC interest) when the loan is used to buy, build or substantially improve the underlying property. An improvement is substantial if it:
- Adds to the value of the home
- Prolongs your home's useful life, OR
- Adapts your house to new uses
That means you have some flexibility if you're planning to use a home equity loan or HELOC to finance upgrades, improvements, or renovations to a first or second home you own. For example, you might be able to deduct interest paid for loans to replace your HVAC system, adapt the home to accommodate a person with disabilities, or install a value-add product, such as solar panels or a whole house generator.
This provision of the IRS code doesn't cover basic repairs and maintenance. So if you're doing something simple like painting walls, for example, you probably wouldn't be able to deduct interest paid on a home equity loan or HELOC. Unless, of course, the painting is part of a larger renovation project that satisfies one of the three requirements listed above.
Deducting home equity loan interest examples
The example below demonstrates when home equity loan interest is tax-deductible. Say you bought a home in 2020 with a $500,000 first mortgage loan. The property value has increased to $750,000 so you decide to take out a $150,000 home equity loan.
As long as the same property secures both loans and you're using the money to make improvements or repairs to add value, all of the interest paid on the loans would be deductible. But suppose that you use $50,000 of the loan to consolidate credit card debt. You wouldn't be able to deduct the interest in that instance.
What if you take out a $500,000 loan to purchase a first home, then two years later, you borrow $250,000 more with a home equity loan? And instead of making improvements to your first home, you use the loan proceeds to buy a vacation home? Since the loan is secured by your first home, not the second home, you wouldn't be able to deduct the interest.
Is Home Equity Loan Interest for Rental Property Tax Deductible?
Home equity loan interest for a rental property that you occasionally use yourself is tax deductible if:
- You're using the loan to buy, build or substantially improve the property
- You live in the property for part of the year and rent it out the rest of the time
But what if you have a rental property that's used solely as an investment? The mortgage interest deduction, including the deduction for home equity loan interest, doesn't extend to rental properties. Instead, you classify the interest as a business expense and deduct it from the rental income.
Most landlords report rental income and deductions on Schedule E. You can deduct mortgage interest, property taxes, insurance, depreciation, and other costs. However, if your deductions exceed rental income, you’ll be subject to passive activity loss limitations. Many can deduct up to $25,000 of losses against their ordinary income. But the deduction phases out as your income rises.
Deducting interest and other rental property expenses can reduce your taxable income for the year, which could decrease your tax liability. It’s helpful to consult with a tax professional about what you can and can't deduct before investing in rental property.
How to Deduct Home Equity Loan Mortgage Interest
Getting a home equity loan can be more attractive for some borrowers than using a personal loan or credit card to finance home repairs or improvements. So if you're planning to take out a home equity loan or HELOC, it helps to know how to deduct loan interest.
Here's the first thing to know: You'll need to itemize deductions to write off home equity loan interest. Itemizing means you list individual deductions on a Schedule A instead of taking the standard deduction.
Today, few taxpayers itemize. The standard deduction is now so high since passage of the Act that the percentage of taxpayers who itemize dropped from 30% to under 14%.
Here are the standard deduction amounts for the 2021 tax year:
- $25,100 for married couples filing jointly
- $12,550 for single filers or married people filing separately
- $18,800 for head of household
Organizing your tax documents can help you decide if itemizing makes sense. For example, you'll want to gather mortgage interest statements (Form 1098) provided by your lender along with documentation for any other deductible expenses, such as real estate taxes, personal property taxes, and charitable donations.
You'll also need a paper trail documenting how you spent the home equity loan proceeds. For example, you should save receipts for material or supply purchases, contractor invoices, and fees for building permits.
Using an online tax calculator can help you estimate your potential tax liability with the standard vs. itemized deductions before you borrow with a mortgage or home equity loan.
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