Can You Deduct Your Home Equity Loan Interest?

You pay interest on your first mortgage and home equity loan, but are home equity loans tax deductible?

There’s a lot of controversy on the topic because the IRS changed the guidelines in 2018, limiting who can write off their home equity loan interest, as well as what types of home equity loan interest can be written off on income taxes.

Keep reading to learn who can deduct mortgage interest and how they qualify.

Depending on how much mortgage debt you have and when you took out the loan, the interest on your home equity loan should be tax-deductible. According to IRS rules, to claim the tax deduction, you’ll need to have used the equity to buy, build onto or substantially improve your primary residence or second home.

The rules for claiming mortgage interest as a tax deduction are the same for first and second mortgages. This includes home equity loans or home equity lines of credit (HELOCs). It also includes refinance loans.

The rules for deducting interest on a home equity loan or HELOC changed as of December 16, 2017, when the Tax Cuts and Jobs Act was passed.

Here’s how the TCJA affects whether you can deduct your home equity loan interest.

• For home equity loans opened before the TCJA: If you borrowed your home equity loan before the TCJA, you can deduct mortgage interest on loans up to $1 million. This includes first and second mortgage loans on a primary or second home. However, married taxpayers filing separately can deduct interest on loans for a maximum of $500,000.

• For home equity loans opened after the TCJA: Any loans borrowed after December 16, 2017, are subject to the TCJA limits of $750,000 in total mortgage debt. This includes loans on a first or second home. However, married filing separate taxpayers can only deduct interest on loans up to $375,000.

Here’s a quick example of how this works.

You borrowed $300,000 to buy your primary residence in 2018. Then a year later, you borrowed $100,000 from the home’s equity to buy a vacation home. Because you didn’t use the $100,000 to buy, build, or improve the house the loan is on, you can’t deduct the interest on the $100,000 loan.

Now, let’s say you borrowed $300,000 for your primary residence in 2018 and 6 months later borrowed another $200,000 to buy a second home. This time, however, the loan for the second home uses the second home as collateral. Because the $500,000 limit is lower than $750,000, you can deduct the interest on both loans.

Knowing how to deduct home equity loan interest is important. The key is to have proper documentation and to understand the IRS rules.

1. Make Sure Your Loan Qualifies

Before you deduct home equity loan interest, you must ensure your loans qualify. Here’s what to consider.

• The mortgage debt doesn’t exceed the limits. Any loans you have on a property shouldn’t exceed a total of $750,000. This includes the first mortgage you used to buy the home and any second mortgages you borrowed, whether a HELOC or home equity loan. Determine when you borrowed the funds and correlate them with the limits of $750,000 after 2018 or $1 million before 2018.

• A “qualifying residence” secures the home equity loan. For your loans to count, they must be on a qualifying residence, such as your primary residence (where you live), or a second home, such as a vacation home. However, the home you used the funds to buy, build, or improve must be the collateral for the loan.

• The debt isn’t higher than the qualifying home(s) value. If you owe more than the home’s value, you’re upside down on your home. The IRS won’t allow you to deduct interest on any loans that exceed the value of the collateral.

• The funds were used to buy, build or improve a qualifying home(s). To qualify for the mortgage interest rate deduction, you must use the funds to buy a property, build your own home, or renovate your existing home. A few examples of substantial home improvements include replacing the roof, adding a room addition, or remodeling the kitchen.

2. Collect Your Mortgage Statements and Other Documents

You must prove how you used the funds to claim the interest deduction. You’ll first need your mortgage statements to prove how much you borrowed. This is necessary to ensure you’re within the limits imposed by the TCJA.

Next, you must have receipts, contracts, and any other documentation proving how you used the funds. For example, did you buy your house with them? Finally, show your Closing Disclosure and mortgage deed, and you can prove how you used the funds.

If you used the funds to renovate your home, you’d need all receipts for materials, labor and any other costs incurred to renovate the property.

3. Itemize and Calculate Your Deductions

To determine your deductions, you should add up the total payments allowed for tax deductions. Mortgage interest is one example, but you may also write off your property taxes and mortgage points if they are on your primary residence.

4. Factor in Your Mortgage Points

If you borrowed the mortgage this tax year, you could also deduct the mortgage points as a part of your itemized deductions. Mortgage points are money you pay to buy down your interest rate or as a fee the lender charges for underwriting your loan. Because mortgage points are prepaid mortgage interest, you can deduct them from your taxes if the loan is for your main home, and it’s normal business practice in your area to pay mortgage points. Whether you pay the points in cash at closing or roll them into your loan will affect how much of the points you can write off in a tax year. Check with your mortgage originator and/or tax advisor to verify your situation.

5. Choose Between a Standard or Itemized Deduction

To take the mortgage interest deduction, you must itemize your deductions. But it doesn’t always make sense to do so.

Before you do too much legwork, determine the estimated amount of your interest payments using the 1098 from your mortgage lender. If you don’t have many other deductions to add to the interest deduction and it isn’t close to $12,950 for single filers or $25,900 for married filing jointly filers, you are better off taking the standard deduction because you’ll save more money on your taxes.

Taxpayers have a lot of questions about deducting interest on home equity loans.

Is Home Equity Loan Interest Tax Deductible in 2022?

According to the Tax Cuts and Jobs Act, home equity loan interest is tax deductible through 2026. This means you can deduct your home equity loan interest if it meets the IRS guidelines and you itemize your deductions.

What Forms Will I Need to Deduct My Home Equity Loan Interest?

To deduct your home equity loan interest, you’ll need the 1098 forms from your mortgage lender and itemized receipts to prove how you used the funds.

Is HELOC Interest Tax Deductible?

HELOC interest can be tax deductible if it meets the IRS guidelines. The rules are the same for a home equity loan and HELOC. This means the loans must not exceed the stated loan limits, and you must prove you used the funds to buy, build, or improve a home.

Borrowers can deduct their home equity loan interest if they use the funds on the home used as collateral. So, whether you borrow a home equity loan to help you buy or build a home or borrow it after you own the home to make improvements, you may deduct the interest.

If you’re interested in seeing how much you can borrow with a home equity loan, start an application with Rocket Mortgage^® to see if you qualify.