Prior to the Tax Cuts and Jobs Act (TCJA) of 2017, homeowners could claim a slew of additional tax breaks. However, they are no longer viable options. After the TCJA went into effect, it became more difficult to get a deduction while borrowing against the equity in your home—but it is still feasible provided you fulfill specific requirements.
- Interest on a home equity loan or a home equity line of credit (HELOC) may still be deducted from your taxes.
- Don’t get a home equity loan or a HELOC merely for the tax break.
- Because of the large standard deduction, even people who qualify for a home equity tax deduction may find it inconvenient to do so.
Types of Home Equity
You may borrow against the equity in your house in two ways. A home equity loan or a home equity line of credit are also options (HELOC).Both enable you to borrow against the equity in your house, often at significantly cheaper interest rates than other types of unsecured loan.
Choosing between the two is determined by your present position, precisely how much money you need over what time frame. Both a home equity loan and a HELOC entail the same danger of foreclosure if you fail to repay them, or of being underwater if the value of your property falls dramatically. The regulations for home equity tax deductions apply to both home equity loans and HELOCs.
Specific Tax Rules
Certain requirements must be met in order to qualify for a tax deduction on your home equity loan or HELOC.
Only the interest on the home equity loan or HELOC is deductible, and it must be used to “purchase, construct, or significantly renovate the taxpayer’s house that secures the loan.”
The Internal Revenue Service does not specify what counts and what does not under “purchase, construct, or significantly enhance.” If you’re unclear if your costs will be included, retain your receipts and get specialized counsel from a tax preparer.
In addition to being limited to specified costs, the interest deduction is only allowed for loans totaling $750,000. This implies that if you claim the mortgage interest deduction for both your main mortgage and your home equity loan or HELOC, you may only claim interest on a total loan value of up to $750,000.
Lowering Your Tax Burden
Leveraging your home’s value only to reduce your taxes may not be the smartest financial decision. Because of the large standard deduction, you may not have tax savings, and even if you do, you’re paying money to the bank to avoid paying a comparable amount to Uncle Sam—and destroying the value in your house in the process.
Itemizing vs. the Standard Deduction
In addition to restricting the ability to claim the mortgage interest deduction, the TCJA also increased the standard deduction. In 2022, the standard deduction for solo taxpayers and married couples filing separately is $12,950, while for married couples filing jointly, it is $25,900.
This implies that for filers who do not currently itemize, adopting the standard deduction may result in the largest refund unless they have a very high interest rate and loan amounts. Those who currently itemize for various reasons may find that adding home equity tax deductions reduces their tax burden.
What is the difference between a home equity line of credit (HELOC) and a home equity loan?
How much equity do you need for a home equity loan or a HELOC?
Individual lender restrictions vary, but a HELOC requires a minimum of 75% equity in your property. For a home equity loan, most lenders want at least 80% equity.
How do I calculate the equity in my home?
Subtract the current amount on any loans on your house from the current estimated worth of your property to figure the percentage of equity you have in your home. Divide that total by the worth of your house.
Here’s how it works with a $400,000 property and a $300,000 loan debt.
$400,000 – $300,000 = $100,000
$100,000 ÷ $400,000 = 25%
In other words, this homeowner has 25% equity.
The Bottom Line
Newer tax laws still enable you to claim a home equity tax deduction on the interest paid on your HELOC or home equity loan as long as the money is used to purchase, develop, or significantly enhance the property on which the HELOC or home equity loan is based. Because of the larger standard deduction, you may not be able to claim the interest paid for the home equity tax deduction unless you itemize your return.
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