Is Interest On A Home Equity Loan Tax Deductible?

Most homeowners understand that the funds from a home equity loan can be used for anything from debt consolidation to renovation projects. But did you know that some uses of a home equity loan could help you save on your yearly tax return? 

Due to recent tax law changes, the interest on a home equity loan can be tax deductible, including interest paid on your second home. In this article, we’ll cover everything you should know about claiming a home equity loan tax deduction.

Are Home Equity Loans Tax Deductible?

According to the Internal Revenue Service (IRS), mortgage interest on a home equity loan is tax deductible as long as the borrower uses the money to buy, build or improve a home.

For instance, single or married homeowners filing separately can take the interest deduction on up to $375,000 in equity loans taken out after December 2017. Married couples filing jointly can claim up to $750,000. For loans taken out before December 2017, taxpayers can claim up to $500,000 or married couples filing jointly can claim up to $1 million.

However, home equity funds used for any purposes other than for your home aren’t tax deductible. The good news is you can take the deduction on a first or second home, just not investment homes – they have other tax deductions you can take advantage of to lower your tax liabilities.

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How Does The Home Equity Loans Tax Deduction Work?

The Tax Cuts and Jobs Act of 2017 (TCJA) limited when homeowners can take the home equity loan tax deduction, but there are still ways to qualify for this tax break.

For example, if you own a home and take out a home equity loan for $100,000 to add a room and prove you used the entire $100,000 for that purpose, you can deduct the mortgage interest paid.

On the flip side, if you took out a loan for $200,000, used $100,000 for home improvements and the other $100,000 for credit card debt consolidation, you could only deduct the interest on the first $100,000 used to renovate your home. This is because the funds used for debt consolidation aren’t deductible.

Here’s another example.

You borrowed $100,000 from your home’s equity and used the funds to pay for your child’s college education instead of taking student loans. You can’t take the tax deduction because you didn’t use the funds for a primary residence or second home.

How To Claim A Home Equity Loan Tax Deduction

If you’ve recently used a home equity loan for home improvements or to build a house, you might be eligible for the related tax deduction. To take advantage of this tax benefit, follow these steps:

1. Confirm Your Eligibility

First, determine if your loans meet the IRS requirements for the home equity loan tax deduction, including:

2. Review Your Records

You must provide receipts, bank statements, contracts and proof of payments made to contractors or other home improvement companies. In addition, you must prove how you used the funds so there’s no assumption it was used for anything other than your home.

Your receipts should include any costs from home improvements, including labor, materials and permits. The more records you have for how you used the funds, the easier it is to take the mortgage interest deduction because it must be proven beyond a reasonable doubt.

3. Assess Your First And Second Mortgages

To determine if you can take the interest deduction, look at the most recent statements from your first and second mortgage. The loans must not exceed the IRS threshold. It takes only a few minutes to determine if your loans qualify. Any amount above the limit won’t be eligible.

If you aren’t sure of your loan amount, you can contact your lender or reference your closing documents to determine how much you borrowed.

4. Prepare Necessary Documentation

To take the home equity loan tax deduction, you must prepare your 1040s by providing the amount of interest paid on your loans.

It should be straightforward to transfer the numbers from your 1098; however, if you paid additional interest that isn’t reported on the 1098, provide the necessary documentation to prove the payments.

Remember to have as much documentation as possible. The IRS typically uses the numbers provided on the official tax documents sent to you by your lender.

5. Itemize Your Deductions

The only way to take the interest deduction is to itemize your deductions. Since the standard deduction has increased so much, it’s important to compare your itemized deductions to the standard deduction to ensure you take the one worth more.

For the 2023 tax year, the standard deduction is $13,850 for single filers and $27,700 for those who are married and filing jointly. Add your itemized deductions up to see if they exceed these amounts. Then, include any other itemized deductions you’re eligible for to see which deduction is greater.

Tax Deduction Examples

Let’s say, for example, you paid $10,000 in interest on your first loan and $3,000 on your second mortgage. If you don’t have any other itemized deductions and you’re married filing jointly, it wouldn’t make sense to take the itemized deductions so you won’t deduct your home equity loan interest.

In other words, you can deduct more with the standard deduction of $27,700 than the $13,000 you’d itemize for your mortgage interest. In this scenario, you don’t need to claim the home equity loan tax deduction to save money on your tax return.

If, on the other hand, you had itemized deductions that, together with the home equity loan interest, exceeded $27,700 (for married and filing jointly taxpayers), it makes sense to do the legwork and itemize your deductions to lower your tax liability.

If you have any questions or difficulty, it’s wise to consult a tax professional.

Is Home Equity Line Of Credit Interest Tax Deductible?

If you used a home equity line of credit (HELOC) instead of a home equity loan, you might wonder if you qualify for an interest deduction. While these two types of home equity financing operate differently, they have the same tax rules. If you paid HELOC interest, you could qualify for the deduction if you used the funds to buy, build, or improve your home.

But keep in mind that you’ll need to prove to the IRS how those funds were spent. That means you must keep careful records to claim the home equity loan tax deduction.

The Bottom Line: Home Equity Loans Can Be Tax Deductible

Home equity loans can help you use your home’s equity. If you use them to improve your home or build a second home, you may be eligible to take the tax deduction on the interest paid.

With rising home values, many homeowners today have equity in their homes to use however they need it. If you’re ready to tap into your equity, today.

Miranda Crace

Miranda Crace is a Staff Writer for Rocket Companies, bringing a wealth of knowledge about mortgages, personal finance, real estate and personal loans for over 10 years. Miranda is dedicated to advancing financial literacy and empowering individuals to achieve their financial and homeownership goals. She graduated from Wayne State University, where she studied PR writing, film production and film editing. In her spare time, Miranda enjoys traveling, actively engages in the entrepreneurial community, and savors a perfectly brewed cup of coffee.

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