A Home Equity Line of Credit (HELOC) is a revolving line of credit that homeowners can access by leveraging the equity in their homes. Just like a primary mortgage, borrowers are required to pay interest on any amounts withdrawn from the HELOC. Over time, the interest payments can accumulate significantly. Fortunately, homeowners who opt to itemize deductions on their tax returns may generally be able to deduct some of the interest paid on their HELOCs from their taxable income. However, there are specific conditions under which this deduction applies, notably whether the funds were utilized for enhancing the property.
To ascertain if HELOC interest qualifies as tax-deductible, homeowners must adhere to certain IRS regulations. The core stipulation is that the borrowed funds must be used to “buy, build, or substantially improve” the home against which the HELOC is secured. If the money is utilized for other purposes—like paying off unsecured debts or medical expenses—the interest payments do not qualify for deduction. Additionally, with the enactment of the Tax Cuts and Jobs Act (TCJA) in December 2017, new rules concerning the deductibility of HELOC interest were introduced. For HELOCs initiated after this date, the maximum deductible amount is limited to interest paid on loans up to $750,000, or $375,000 for those filing separately, provided those funds were applied to eligible expenses like home improvements.
If a HELOC was taken out before the TCJA was enacted, homeowners can still deduct interest on loans up to $1 million, or $500,000 for those married filing separately, without restrictions on how the funds are used. Importantly, to be eligible for the interest deductions, the HELOC must be secured by either the primary or secondary home owned by the taxpayer. In cases where a homeowner’s combined mortgage balance exceeds the TCJA limit—for instance, with a primary mortgage and a HELOC—the allowable deduction on the interest is calculated based on the total amount of qualified debt, which in this example would limit deductions to the first $750,000 in loan balances.
Tax laws are subject to change, and the provisions set forth by the TCJA are scheduled to expire at the end of 2025 unless Congress introduces new legislation. Therefore, there is potential for the deduction limits to revert to pre-TCJA standards following this period. Taxpayers considering claiming the HELOC interest deduction are advised to ensure they understand the limits applicable to their situation based on when their HELOC was established and how the funds were subsequently utilized.
When planning to claim a HELOC interest tax deduction, it is crucial for taxpayers to confirm their eligibility. This involves evaluating the total home debt, the purpose of the HELOC, and the date the credit line was opened. Moreover, it’s important to note that taxpayers must itemize their deductions to claim the HELOC interest, as those opting for the standard deduction would be ineligible. An evaluation of itemized deductions, in comparison to the standard deduction for their filing status, can help in determining whether itemizing is beneficial. For example, as of the 2024 tax year, standard deductions are set at $14,600 for single filers and married couples filing separately, $21,900 for heads of household, and $29,200 for married couples filing jointly.
Proper documentation is crucial when claiming tax deductions, including maintaining records such as Form 1098, which details mortgage interest paid, and Form 1040 for itemizing deductions. Taxpayers should also keep any relevant bank statements and receipts. The IRS suggests retaining tax documents for at least two years from the payment date or three years from filing, whichever is later, to prepare for possible audits. Additionally, people should be mindful of the nature of their HELOC interest rates—variable rates are common and can fluctuate based on economic conditions and individual credit scores, potentially impacting total interest paid over time.
Although using funds from a HELOC to pay taxes is possible, it is critical to remember that such interest will not be tax-deductible, as it does not meet the criterion of being used to purchase, build, or improve a property. Understanding the nuances surrounding HELOC interest deductions can significantly affect a homeowner’s tax situation, making it essential to navigate these regulations carefully. Thus, consulting tax professionals and staying informed about legislative changes can be beneficial for homeowners leveraging their home equity for financial needs.