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When you borrow on your home’s equity, there’s a bonus: The interest you pay each year is tax-deductible up to a government-imposed limit, the same as on your home mortgage. The rules for claiming that deduction on home equity borrowing are a little different.
The deduction on mortgage interest is dear to Americans and is popularly thought to encourage middle-class homeownership. In fact, the deduction dates to 1913, when few people had mortgages. It was implemented with the adoption of the 16th Amendment to the Constitution, which created a federal income tax. Later, when homeownership became more widespread, the deduction grew in importance for middle-class homeowners.
Claiming the deduction is “nice and simple. It’s easy,” says Jeff A. Schnepper, a Cherry Hill, New Jersey, attorney and the author of “How to Pay Zero Taxes, 2017: Your Guide to Every Tax Break the IRS Allows.”
To deduct the interest paid on your home equity line of credit, known as a HELOC, or on a home equity loan, you’ll need to itemize deductions at tax time using IRS Form 1040. That’s worth doing only if your deductible expenses add up to more than the amount of the standard deduction: $6,350 for a single person and $12,700 for a married couple filing jointly in 2017.
The IRS allows interest deductions on up to $1 million in mortgage borrowing. In addition, you can deduct interest on up to $100,000 of home equity borrowing and spend that money on anything, real-estate-related or not. For the 2017 tax year:
You can deduct interest on the full $100,000
The limit is $50,000 each for married taxpayers filing taxes separately
That puts the total limit on deductible mortgage borrowing at $1.1 million.
“Interest on the first $100,000 is deductible as an itemized expense, no matter what the funds are used for,” says John R. Lieberman, a certified public accountant and a managing partner at Perelson Weiner LLP, a New York City accounting firm. In other words, if your HELOC amount is $163,000, you can’t deduct all the interest paid, only the portion paid on the first $100,000.
To deduct interest on the rest of the HELOC loan, you need to spend it on improving your home. “You can take out a million-dollar HELOC and deduct the interest (up to your total indebtedness of $1.1 million, including your mortgage) if you are using it to improve your home,” Lieberman adds.
Home equity loans and lines of credit are different products.
With the home equity loan, you borrow a lump sum over a fixed period of time at a fixed rate of interest. HELOCs are more flexible. You get qualified to borrow a certain amount and can withdraw it during a draw period, usually 10 years. The interest rate on a HELOC is adjustable, or variable. The rate changes along with market rates.
Despite the differences, the IRS rules on deducting interest are identical for home equity loans and HELOCs.
Before tax time, you should receive an IRS Form 1098, or the Mortgage Interest Statement, from your lender. It shows the interest you paid on your home equity loan or line of credit in the previous year. Call your lender if you don’t get a 1098 or if you want help in understanding it.
To deduct that interest when filing taxes and filling out IRS Form 1040, Schnepper says:
Itemize your interest paid on line 10 of Schedule A
If you did not get a form from your lender, write the interest paid on line 11
The IRS doesn’t care how you use the funds you’ve borrowed on your home’s equity. “The money from your home equity loan or line of credit can be used for anything at all,” Schnepper says. You don’t need to use it to improve your home.Still, there are smart uses and not-so-smart uses for your funds. After all, borrowing on equity is risky — you can lose the home if you default on the payments.
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