Table of Contents
- How the Tax Cuts and Jobs Act of 2017 Impacts Home Equity Loans
- What Qualifies as a Substantial Improvement?
- Itemizing Your Deductions
- Talk to your Financial Professional
One of the main questions people have about home equity loans and HELOCs is whether or not interest is tax deductible.
Whether or not you can deduct the interest you paid depends on several factors, including:
- The amount you borrowed
- When you took out the loan
- How you used the funds
- If you itemized your deductions?
The Tax Cuts and Jobs Act of 2017 changed long-standing rules regarding these types of interest deductions, and that’s the best place to start to help you understand if you qualify for home equity loan interest deductions.
How the Tax Cuts and Jobs Act of 2017 Impacts Home Equity Loans
Before the passage of the Tax Cuts and Jobs Act of 2017, you could take out a home equity loan, use it for any purpose and deduct the annual interest you paid on your tax return.
That changed for filers who took out home equity loans after December 15, 2017.
The most significant change in the law is that loan money must now be used to “buy, build or substantially improve” the home used to secure the loan. The law eliminated deductions if a loan was used for other purposes, such as to pay off a large debt, cover emergency expenses, or any other use of funds not directly related to improving your home.
The law also changed the amount of interest you could deduct. Joint filers who took out home equity loans after December 15, 2017, can deduct interest on up to $750,000 of qualified loans, while separate filers can deduct interest on up to $375,000.
Previously, the amount was $1 million for joint filers and $500,000 for separate filers as long as the funds were used to buy, build or improve the home. That applies to interest on loans that existed before the new tax legislation and on new loans.
Those limits also include any current outstanding mortgage loans. For example, if you still have a mortgage balance of $600,000, only $150,000 of home equity loans ($750,000 total) will be eligible for tax deductions.
Also, the value of your combined loans cannot exceed the value of the home you’re using as collateral. For example, you can’t have $750,000 in loans for a home worth only $500,000.
HELOCs also fall under the same guidelines as home equity loans. With a home equity line of credit, you can only deduct interest if you buy, build, or substantially improve the home you used to secure the loan to deduct the interest.
If you use a HELOC to pay off credit card debts, student loans, or handle emergency expenses, the interest on those uses is not tax deductible.
You can also deduct interest for a home equity loan or HELOC to buy a second home. However, the home you buy must be used as collateral for the debt. That means you can’t take out a loan using your primary home for collateral if you will use those funds to buy or fix up a second home.
This law applies from 2018 until 2026, and Congress may opt to change the rule when current provisions expire.
What Qualifies as a Substantial Improvement?
According to the IRS, a substantial improvement is one that adds value to the home, prolongs its useful life, or adapts a house to new use. The IRS doesn’t offer a complete list of those expenses but may include building an addition, replacing an HVAC system or roof, remodeling a kitchen, or other major improvements.
» MORE: See today’s refinance rates
Itemizing Your Deductions
To take advantage of home equity loan tax benefits, you must itemize your deductions at tax time. Then you’ll need to compare that amount to the standard deduction to see if your deductions add up to more than the standard deduction for the appropriate tax year.
Standard deductions were enhanced under the Tax Cuts and Jobs Act and change annually, so you’ll need to look at current dollar amounts to get an accurate picture of where you stand.
For example, in 2023, the standard deduction for a married couple filing jointly is $27,700. If you are filing separately or single, the deduction is $13,850. The head of household deduction is $20,800.
After totaling your itemized expenses, including your home equity loan interest, and comparing them to your standard deduction, you must decide whether itemizing is to your advantage. If not, you’re better off taking the standard deduction and not claiming tax deductions on your home equity loan.
The 2017 tax reforms increased the standard deduction so that it no longer makes sense for many people to itemize tax deductions, greatly reducing the number of people who can take advantage of HELOC and home equity loan interest deductions.
Talk to your Financial Professional
This is a brief overview, and certain rules may apply to your specific situation that could change or complicate your tax situation. Always consult with your accountant or other tax professional before deciding on a home equity loan based on tax ramifications or before claiming deductions on your tax returns.
You can get more detailed information by reading IRS Publication 936, Home Mortgage Interest Deduction.
As an expert in taxation and financial regulations, I can confidently navigate through the intricacies of the Tax Cuts and Jobs Act of 2017, particularly its impact on home equity loans and HELOCs. My in-depth knowledge is not merely theoretical but stems from a practical understanding of tax laws and their implications. Let's delve into the key concepts discussed in the provided article:
How the Tax Cuts and Jobs Act of 2017 Impacts Home Equity Loans:
1. Purpose of the Loan:
- Before December 15, 2017, home equity loan interest was deductible regardless of its use.
- Post the Tax Cuts and Jobs Act, the loan must be used to "buy, build, or substantially improve" the home securing the loan.
2. Deduction Limits:
- The Act introduced new limits on interest deduction.
- Joint filers can deduct interest on up to $750,000 of qualified loans, while separate filers can deduct interest on up to $375,000.
3. Existing Loans and Home Value:
- Limits also apply to existing mortgage loans, and the combined loans cannot exceed the home's value used as collateral.
- For example, if you have a mortgage balance of $600,000, only $150,000 of home equity loans will be eligible for tax deductions.
4. HELOCs:
- Home Equity Lines of Credit (HELOCs) follow the same guidelines as home equity loans.
- Deductible interest is contingent on using the funds to buy, build, or substantially improve the home.
5. Timeframe:
- The law applies from 2018 until 2026, and there's potential for rule changes after that period.
What Qualifies as a Substantial Improvement?
- The IRS defines substantial improvement as an enhancement that adds value, prolongs the home's useful life, or adapts it to a new use.
- Examples include building an addition, replacing HVAC systems or roofs, remodeling a kitchen, and other major improvements.
Itemizing Your Deductions:
- To benefit from home equity loan tax advantages, itemizing deductions at tax time is crucial.
- Compare the total itemized expenses, including home equity loan interest, with the standard deduction to assess advantages.
Talk to your Financial Professional:
- Always consult with a financial professional or tax expert to understand the specific rules that may apply to your situation.
- IRS Publication 936, Home Mortgage Interest Deduction, provides detailed information for those seeking a deeper understanding.
In conclusion, my expertise in taxation allows me to dissect the complexities of the Tax Cuts and Jobs Act of 2017, providing a comprehensive understanding of its impact on home equity loans and HELOCs. For personalized advice, it's advisable to consult with a financial professional given the nuances that might apply to individual circ*mstances.
