Tax Loophole for Deducting Home Equity Loan Interest

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Tax Loophole for Deducting Home Equity Loan Interest

The Tax Cuts and Jobs Act (TCJA) of 2017 included some new tax advantages while eliminating others. Some of the tax changes directly impacted people who own or want to buy a property.

One of the repealed legislation altered the tax treatment of home equity loan interest. Much of that deduction has been essentially repealed—at least until the end of 2025. However, the IRS has created a loophole in existing tax legislation that allows certain homeowners to continue benefitting from the home equity loan interest deduction, but only if they fulfill specific requirements.

Key Takeaways

  • Despite provisions in the Tax Cuts and Jobs Act (TCJA), home equity loan interest, as well as interest on home equity lines of credit (HELOCs) and second mortgages, may still be deductible for certain homeowners.
  • To qualify for this deduction, the loan funds must be used for an IRS-approved purpose, specifically “buying, building, or significantly improving the taxpayer’s house.”
  • Personal debts or other non-qualified costs cannot be paid using loan proceeds.
  • The deduction isn’t limitless. If the mortgage was approved after December 15, 2017, only interest up to $750,000 is deductible.

Rules for Deducting Home Equity Loan Interest

Among the modifications made by the TCJA is a lowering in the ceiling on the mortgage interest deduction. Only interest paid on mortgage debt up to $750,000 may be deducted if the loan was taken out after December 15, 2017. The prior maximum was one million dollars. Under some conditions, this limit also applies to home equity loans, home equity lines of credit (HELOCs), and second mortgages.

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The IRS released an advising note to taxpayers in February 2018 addressing the status of the home equity loan interest deduction under the new tax rules. This letter said that interest on home equity loans, HELOCs, and second mortgages may still be deductible if used for an IRS-approved purpose. For the interest to be deducted, these loans must be used to “purchase, develop, or significantly enhance the taxpayer’s residence that secures the loan.” There were no limitations on how homeowners might spend monies prior to the TCJA.

While the IRS did not provide a list of costs that would be covered by the law’s provisions, its guidance did give some instances of eligible home renovation expenses, such as the construction of an extension to your house. Other uses for a home equity loan or a HELOC that qualify for the deduction include:

  • Putting a new roof on the house
  • Replacing your HVAC system
  • Finishing a large kitchen or bathroom renovation project
  • Resurfacing your driveway

The total sum of your principal mortgage and a home equity loan or a HELOC is subject to the $750,000 mortgage interest deduction maximum.

Best Practices for Claiming the Home Equity Interest Deduction

There are a few things to keep in mind if you own a property and want to claim the home equity loan interest deduction. First and foremost, the funds must be utilized for house upgrades or renovations. You cannot, for example, claim the deduction if you use home equity profits to pay for personal expenses or to consolidate credit card debt. The same is true if you take out a loan and deposit the proceeds in a savings account as an emergency reserve.

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Furthermore, the improvements must be completed on the property for which the home equity loan is being obtained. You cannot, for example, take out a loan on your principal property and then use the proceeds to restore your lakeside cottage.

Keep detailed records of your spending. Although the risks of getting audited by the IRS are relatively minimal, you should not take any chances. If you want to utilize a home equity loan or HELOC to pay for house repairs or renovations, retain all receipts and bank records that demonstrate where the money went.

Finally, keep in mind that this deduction is not limitless. If you took out a house loan after December 15, 2017, you may deduct the interest on up to $750,000 in debt. If your total mortgage debt exceeds that amount, you will not be able to deduct the whole amount of interest paid. Mortgages received prior to that date are subject to the $1 million restriction. Because interest on older mortgages is still deductible on loans up to $1 million, consult with a tax expert to see what you may deduct if you have both an older mortgage and a home equity loan that qualifies for deductions.

What is the cap on home equity loan deductions?

The interest on a home equity loan may be deducted up to $750,000. This limit applies to loans made after December 15, 2017. The ceiling is $1 million for loans received prior to that date.

Is home equity line of credit (HELOC) interest tax deductible?

Interest on a home equity line of credit (HELOC) may be deducted, but only if the funds are used for house renovations. The Tax Cuts and Jobs Act (TCJA) removed interest deductions if the funds are used for something else, such as debt consolidation.

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Are home improvement loans tax deductible?

You may deduct interest on up to $750,000 of home equity loan or HELOC money used for home upgrades. In reality, the only way to deduct the interest on these loans is to utilize them for house upgrades.

The Bottom Line

A home equity loan, often known as a HELOC, may be a handy source of money for home improvements. A tax deduction for the interest you pay is an extra bonus. Take the time, like you would with any other loan, to research interest rates and loan conditions from several lenders to discover the best offer.

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