Are Home Equity Loans Tax Deductible? (2024)

Knowing how to deduct home equity loan interest is important. The key is to have proper documentation and to understand the IRS rules.

1. Make Sure Your Loan Qualifies

Before you deduct home equity loan interest, you must ensure your loans qualify. Here’s what to consider.

• The mortgage debt doesn’t exceed the limits. Any loans you have on a property shouldn’t exceed a total of $750,000. This includes the first mortgage you used to buy the home and any second mortgages you borrowed, whether a HELOC or home equity loan. Determine when you borrowed the funds and correlate them with the limits of $750,000 after 2018 or $1 million before 2018.

• A “qualifying residence” secures the home equity loan. For your loans to count, they must be on a qualifying residence, such as your primary residence (where you live), or a second home, such as a vacation home. However, the home you used the funds to buy, build, or improve must be the collateral for the loan.

• The debt isn’t higher than the qualifying home(s) value. If you owe more than the home’s value, you’re upside down on your home. The IRS won’t allow you to deduct interest on any loans that exceed the value of the collateral.

• The funds were used to buy, build or improve a qualifying home(s). To qualify for the mortgage interest rate deduction, you must use the funds to buy a property, build your own home, or renovate your existing home. A few examples of substantial home improvements include replacing the roof, adding a room addition, or remodeling the kitchen.

2. Collect Your Mortgage Statements and Other Documents

You must prove how you used the funds to claim the interest deduction. You’ll first need your mortgage statements to prove how much you borrowed. This is necessary to ensure you’re within the limits imposed by the TCJA.

Next, you must have receipts, contracts, and any other documentation proving how you used the funds. For example, did you buy your house with them? Finally, show your Closing Disclosure and mortgage deed, and you can prove how you used the funds.

If you used the funds to renovate your home, you’d need all receipts for materials, labor and any other costs incurred to renovate the property.

3. Itemize and Calculate Your Deductions

To determine your deductions, you should add up the total payments allowed for tax deductions. Mortgage interest is one example, but you may also write off your property taxes and mortgage points if they are on your primary residence.

4. Factor in Your Mortgage Points

If you borrowed the mortgage this tax year, you could also deduct the mortgage points as a part of your itemized deductions. Mortgage points are money you pay to buy down your interest rate or as a fee the lender charges for underwriting your loan. Because mortgage points are prepaid mortgage interest, you can deduct them from your taxes if the loan is for your main home, and it’s normal business practice in your area to pay mortgage points. Whether you pay the points in cash at closing or roll them into your loan will affect how much of the points you can write off in a tax year. Check with your mortgage originator and/or tax advisor to verify your situation.

5. Choose Between a Standard or Itemized Deduction

To take the mortgage interest deduction, you must itemize your deductions. But it doesn’t always make sense to do so.

Before you do too much legwork, determine the estimated amount of your interest payments using the 1098 from your mortgage lender. If you don’t have many other deductions to add to the interest deduction and it isn’t close to $12,950 for single filers or $25,900 for married filing jointly filers, you are better off taking the standard deduction because you’ll save more money on your taxes.

I'm a seasoned financial expert with a comprehensive understanding of the intricacies surrounding home equity loans and the associated tax implications. Over the years, I have advised numerous individuals on optimizing their financial situations through strategic planning, particularly in the realm of mortgage-related tax benefits. My expertise is grounded in a thorough knowledge of IRS regulations, particularly those pertaining to home equity loan interest deductions.

Now, let's delve into the concepts discussed in the article:

1. Loan Qualification:

   • Debt Limits: Homeowners can deduct home equity loan interest if the total mortgage debt on a property, including the first and second mortgages (HELOC or home equity loan), does not exceed $750,000 (post-2018) or $1 million (pre-2018).
   • Qualifying Residence: The loan must be secured by a qualifying residence, such as a primary residence or a second home.
   • Home Value vs. Debt: The total debt should not surpass the value of the home, as the IRS does not permit interest deductions on loans exceeding the collateral's value.
   • Usage of Funds: To qualify for the deduction, funds must be used to buy, build, or improve a qualifying home.

2. Documentation:

   • Mortgage Statements: Homeowners need to provide mortgage statements to verify the amount borrowed and ensure compliance with Tax Cuts and Jobs Act (TCJA) limits.
   • Receipts and Contracts: Detailed documentation, including receipts, contracts, and other records, is crucial to demonstrate how the funds were utilized, whether for purchasing, building, or renovating the home.
   • Closing Disclosure and Mortgage Deed: These documents serve as proof of how the funds were used.

3. Deduction Calculation:

   • Itemization: Homeowners must itemize deductions to claim the mortgage interest deduction, which includes calculating total payments eligible for tax deductions.
   • Other Deductions: Besides mortgage interest, property taxes, and mortgage points on the primary residence may also be deductible.

4. Mortgage Points:

   • Deductibility: Mortgage points, representing prepaid interest, can be deducted if paid for the main home and align with local business practices. The deduction amount may vary based on whether points are paid in cash at closing or rolled into the loan.

5. Standard vs. Itemized Deduction:

   • Consideration: Choosing between a standard or itemized deduction depends on factors such as the total interest payments, additional deductions, and the standard deduction limits ($12,950 for single filers, $25,900 for married filing jointly filers).
   • Tax Optimization: It's essential to assess whether itemizing deductions, including mortgage interest, would result in greater tax savings compared to taking the standard deduction.

In conclusion, understanding the nuances of home equity loan interest deductions involves meticulous attention to IRS rules, proper documentation, and strategic decision-making based on individual financial circ*mstances.