A home equity loan can be beneficial for a homeowner when used for purposes like home renovation, paying off other debts that have higher interest rates, or perhaps when making large purchases. A common query that many people have concerning home equity loans is if the interest paid on such a loan is tax deductible. All right, let’s take a closer look at some of the rules regarding home equity loan interest deductions.
What is a Home Equity Loan?
A home equity loan is another method of obtaining a loan through which you use your home as collateral and borrow money based on the equity you have in the house. This refers to the current market value of the house less any mortgage that may be owed on the property. For instance, if the house is worth $300000 and you have a mortgage balance of $180000, you have $120000 in home equity. In case of a home equity loan, a portion of that amount can be borrowed until a particular loan to value ratio is reached and the sum is given in a single lump sum.
Home equity loans typically come in two forms:Home equity loans typically come in two forms:
-
Home Equity Line of Credit (HELOC): This is a line of credit where you can take different amounts, at different times, up to your credit limit, as it is with credit cards. This means that you will be charged interest on the balance that is still outstanding.
-
Closed-End Home Equity Loan: That is more similar to installment loans where you take a certain sum of money, and repay it in regular payments throughout the agreed term of the loan.
Both types of home equity loans use the home as security and let you borrow money based on your home’s value.
Some rules regarding the interest on Home Equity Loan to be chosen
Whether the interest on a home equity loan is tax-deductible is based primarily on how one uses the borrowed funds.
Here are some key rules to understand:
-
Interest on home equity debt that is used for home improvement is usually allowed as a deduction. Some examples include, redecorating your kitchen, fixing up the basement or constructing a pool.
-
Interest can also be deducted if the home equity loan is for qualified higher education expenses such as tuition, books and materials etc.
-
If the loan is used to pay off other non-deductible personal debts, including credit card bills or auto loans, then the interest is generally not tax-deductible.
-
Currently, there is a limit to the amount of interest that can be claimed on home equity debt and this is $100,000. This is the total of any balance of the prior mortgages and the outstanding balance of the home equity line of credit.
-
There are two other important rules dealing with investment homes and second homes that it’s important to know about as well.
- To benefit from the above mentioned points, the qualified taxpayer must use Schedule A on the tax return to itemize deductions and cannot avail standard deduction.
As you can notice from the above information, the nature of the utilization of the loan from the home equity influences the tax deduction of the interest. Business and education expenses present simpler frameworks for deductibility as opposed to personal debts.
How much can you write off?
If your home equity loan interest does qualify for a deduction, the next key question is: what is reasonable when it comes to claiming on the tax return? Here are some points on home equity loan interest deductions:Here are some points on home equity loan interest deductions:
-
Interest on home equity debt is fully deductible on the first $100,000 of debt if acquired after January 1, 2007. This also includes any other normal mortgage loan balances on the property as well as any other outstanding balances.
-
The limit in the first year can be less than $100K based on when the loan was obtained and payments have been initiated.
-
In the event you use the loan proceeds for both, you’ll only be allowed to deduct the interest portion that is used for the qualified deductions. Your lender should advise you on how to allocate those portions.
- However, the Tax Cuts and Jobs Act has a provision that home equity interest is only deductible to the extent that state income tax deductions are allowed if the taxpayer itemizes. For a few of the eligible taxpayers in certain high income tax states it will even lower the amount of home equity loan deductions.
Document Your Expense for the Purpose of Deductions
Documentation is extremely important when it comes to the use of funds, and the same applies to claiming home equity loan interest deduction. Be sure to keep records that show:Be sure to keep records that show:
-
This is because your home equity loan, its origins, and the balances are all important factors that you need to consider carefully before proceeding with this particular financial solution.
-
How the proceeds were spent, like an addition or consolidation
-
Statements of interest paid
- Expenses associated with the proceeds of the loans
By having documents about the purpose and history of your home equity loan, you will be ready to use the right figures to deduct qualifying interest payments on your tax return.
Consider Itemizing Your Deductions
Standard deductions be beneficial above a certain income level whereby noting that it is more financially beneficial compared to making itemized deductions. Yet, due to the recent changes in the tax code that scaled down the state and local tax deductions, more taxpayers are itemizing due to eligible home loan interest deductions.
Remember to add up all possible itemized deductions for categories such as mortgage interest, gifts to charities, medical expenses, and state taxes. Subtract the total from the standard deduction for your filing status. While itemizing does take some extra paperwork, it might make fiscal sense for you this year because of this new deductible home equity loan interest.
In conclusion, the interest that is paid on a home equity loan can be claimed as a tax deduction if the proceeds from the loan was used for a qualified purpose. Debts which are not tax-deductible present fewer deductions as opposed to home repairs or educational costs. Make sure to keep records regarding the purpose of the loan and concerning the interest payments. However, for those homeowners who have deductible interest, an hour or two spent itemizing could result in significant tax savings this year. For any issues on the recoverability of your home equity loan, it is advisable to consult a tax expert.
