The interest paid on HELOCs may be deductible from your taxes, a benefit that does not apply to credit cards or personal loans. HELOCs may have lower interest rates than other types of credit, because the house is used to secure the loan. What is the HELOC tax deduction and who can qualify for it? […]

The interest paid on HELOCs may be deductible from your taxes, a benefit that does not apply to credit cards or personal loans.

HELOCs may have lower interest rates than other types of credit, because the house is used to secure the loan. What is the HELOC tax deduction and who can qualify for it?

Can HELOC interest be deducted from tax in 2023?

Home equity lines of credit, or HELOCs, are credit lines secured by the home that can be used to borrow money on a regular basis. Taxpayers can currently deduct the interest on HELOCs if they meet certain conditions:

  1. You can secure the HELOC by owning a home that is “qualified”. A home qualifies as a second or primary home. If you are renting out your second home you will need to live there for at least 10 days of its rental period or 14 days if it is a primary residence.
  2. Home improvements can be done with HELOC money. You can use HELOC funds to improve your home.
  3. You itemize deductions. You must itemize your deductions instead of using the standard deduction to be eligible for the tax credit on mortgage interest.
  4. You meet loan limits. You can only deduct interest if you have a mortgage, if you borrowed money and – if you are filing a tax return – you met the loan limits.

HELOC interest deduction limitations

You can only deduct interest for home-secured loans if you took out the loan before Dec. 16 2017 or after. What you should know.

  • Mortgages obtained before December 16, 2017.Interest on all mortgages (including HELOCs), which total less than $1,000,000 ($500,000 for married filers filing separately).
  • Mortgages obtained after December 16, 2017.Interest on debts of $750,000 and less is fully deductible.

This limit applies to the combined mortgage debt. If you are single, and take out a mortgage of $350,000 to purchase a house in 2020. Then in 2022, you get a HELOC for $10,000 to finish the floor. Your total mortgage debt would then be $360,000. The interest may still be deducted if the amount is less than the maximum deduction.

Is interest paid on a HELOC deductible for tax purposes?

IRS rules state that interest paid on mortgages is tax-deductible only if it is spent to buy, build or improve the taxpayers’ home as security for the loan. The IRS has outlined a few scenarios where borrowers may or may not qualify.

HELOC Interest Example: When can you deduct it?

You have two bathrooms in your house. But you would like to add a third one, so that your guests can feel more private when they visit. The cost to build walls, install a toilet and plumbing is too high. You take out a HELOC.

If you are upgrading your first or second house and itemizing deductions, you may be able to deduct the interest on the HELOC.

HELOC Interest Example: When you cannot deduct it

A HELOC used for personal expenses unrelated to the improvement of your primary or secondary home would not qualify as a deduction. If you purchase a vehicle, the interest on the HELOC used to pay for it would not qualify as a tax deduction. Imagine you took out a HELOC for other costs, such as adoption or educational expenses. This interest would not be deductible either.

The Mortgage Interest Tax Deduction Process

You’ll use Schedule A when filing Form 1040, 1040-SR or during tax season to list your deductions. The mortgage companies will send you a Form 1098 Mortgage Interest Statement at the end the year. This can be used to help fill it out.

The number of other tax deductions that you claim will determine if it is worthwhile to itemize your mortgage interest. The standard deduction for 2022 is $12.950 for individuals, $25.900 for couples, and $19400 for head of household. The standard deduction is a good option if your itemized deductions and mortgage interest don’t exceed this limit.

Deduction for interest on a HELOC

Here are the next steps you should take if you want to deduct your interest from a HELOC.

  • Check if your HELOC is eligible. The credit line must be secured by either your main residence or your second home. Your total mortgage must not exceed $750,000 or $1,000,000 if borrowed prior to 2018.
  • Verify how you spent HELOC money. To be eligible to claim the tax credit, your HELOC has to be used for qualifying expenses.
  • Take the receipts. As a back-up, keep receipts for purchases made to upgrade your house using HELOC money.
  • Collect financial documents. You should receive Form 1098 from your mortgage lender to show interest on documents. It is possible to assemble your mortgage statement in order to verify what appears on the final mortgage lender’s statement.
  • Completing Schedule A. Complete Schedule A. You can use a tax professional, tax software, or even do it by hand. Attach the completed schedule to your Form 1040 to list your deductions.

Difference between a HELOC (Home Equity Loan) and a Home Equity Loan

Both HELOCs as well as home equity loans are tax-deductible. However, they work in different ways. Home equity loans and HELOCs both allow you to borrow from your home’s equity. However, one of them is a revolving loan while the other is installment.

A HELOC is a type of credit card that allows you to draw money from the line as you require. You are only charged on the remaining balance. Home equity loans, also known as second mortgages, are installment loans that provide you with an initial lump sum and require repayment in equal amounts. The interest will be charged on the lump sum that you borrowed, until it is paid in full.

What’s next?

You can determine whether you are eligible for the deduction of mortgage interest by using tax software that asks questions regarding what you borrowed, and how you spent the money.

If you are unsure about how to file your taxes, it’s worth consulting a tax professional. You can have a professional look at your tax situation to see if interest can be deducted. Knowing that a tax expert has looked over your tax filing can give you some peace of mind.