Both your first mortgage and your home equity loan have interest payments, but are home equity loans tax deductible?
The IRS modified the rules in 2018, limiting who can deduct their home equity loan interest and what kinds of home equity loan interest can be deducted from income taxes. As a result, there is a lot of discussion around the subject.
Read on to find out who qualifies for mortgage interest deductions and how.
Is the interest on home equity loans tax deductible?
The interest on your home equity loan may be tax deductible depending on how much mortgage debt you have and when you took out the loan. According to IRS regulations, you must have utilized the equity to purchase, add to, or significantly enhance your principal residence or second home in order to be eligible for the tax deduction.
Home equity loans and home equity lines of credit (HELOC) interest deduction regulations
Both first and second mortgages are eligible for the same tax deductions for mortgage interest. Home equity loans and home equity lines of credit (HELOCs) fall under this category. Loans for refinancing are also included.
The Tax Cuts and Jobs Act, which was passed on December 16, 2017, altered the regulations for home equity loan interest deductions.
Here is how the TCJA affects your ability to write off the interest on your home equity loan.
Prior to the TCJA, you were able to deduct mortgage interest on loans totaling up to $1 million if you took out a home equity loan. This covers both the first and second mortgages for a primary or secondary residence. However, married taxpayers filing separately can deduct a maximum of $500,000 in loan interest.
Home equity loans that were created after the TCJA are subject to the $750,000 cap on total mortgage debt for loans taken out after December 16, 2017. Including mortgages for a primary or secondary residence. But married taxpayers filing separately are only permitted to write off interest on loans up to $375,000 in total.
Here is a little illustration of how this functions.
In 2018, you took out a $300,000 loan to purchase your primary property. The equity in the house was then used to borrow $100,000 to buy a vacation property a year later. You cannot deduct the interest on the $100,000 loan since you did not utilize the money to purchase, construct, or enhance the home that the loan is secured by.
Let’s imagine you took out a $300,000 loan for your first dwelling in 2018 and another $200,000 loan for a second home six months later. But this time, the collateral for the second-home loan is the second-home itself. You can deduct the interest on both loans because the $500,000 cap is lower than the $750,000 cap.
How to Deduct Interest on Home Equity Loans
It’s crucial to understand how to write off interest on home equity loans. The key is having the appropriate paperwork and being aware of IRS regulations.
1. Verify Your Loan’s Eligibility
You must make sure your loans are eligible before you can deduct interest from home equity loans. Consider the following.
There are no overages in the mortgage obligation. You shouldn’t have more than $750,000 in total debt on any one piece of real estate. This includes any second mortgages you have, including HELOCs and home equity loans, as well as the primary mortgage you used to purchase the house. Find out when you took out the loans, and compare it to the $750,000 after 2018 or $1 million before 2018 limits.
The home equity loan is secured by a “qualifying residence”. Your loans must be secured by a qualifying residence, such as your primary residence (where you now reside) or a second home, such as a vacation home, in order for them to be considered. The house you bought, built, or improved with the money must serve as security for the loan, though.
The debt does not exceed the value of the qualifying house or homes. You are in negative equity if your mortgage balance exceeds the value of your home. If the value of the loan exceeds the value of the collateral, the IRS will not let you deduct interest on the loan.
The money was utilized to purchase, construct, or enhance a qualified home or homes. You must spend the money to purchase a property, construct your own house, or make renovations to an existing one in order to be eligible for the mortgage interest rate deduction. A few examples of significant house upgrades include a new roof, a room extension, or kitchen refurbishment.
2. Gather all Relevant Documents, Including Mortgage Statements
If you want to deduct interest, you must be able to show how you spent the money. To demonstrate how much you borrowed, you must first have your mortgage statements. To make sure you’re inside the TCJA’s restrictions, you must do this.
Next, you must have invoices, agreements, and any other paperwork that demonstrates how the money was spent. Did you, for instance, use them to purchase your home? Finally, you can demonstrate how the money were used by displaying your Closing Disclosure and mortgage deed.
You would want all receipts for the materials, labor, and other expenses made during the renovation of the property if you used the cash for that purpose.
3. Itemize Your Deductions and Calculate Them
You should sum up all of the payments that are eligible for tax deductions to establish your deductions. One illustration is mortgage interest, but you may also deduct property taxes and mortgage points if they apply to your principal residence.
4. Take Your Mortgage Points Into Account
You might deduct the mortgage points as part of your itemized deductions if you took out a mortgage during this tax year. Mortgage points are sums of money that you pay to reduce your interest rate or that the lender assesses as a fee for processing your loan. Mortgage points are prepaid mortgage interest, so if the loan is for your primary residence and paying mortgage points is standard practice in your community, you can deduct it from your taxes. How many points you can deduct in a tax year depends on whether you pay the points in cash at closing or include them in your loan. To confirm your status, speak with your mortgage originator and/or tax counsel.
5. Select an Itemized or Standard Deduction.
You must itemize your deductions in order to qualify for the mortgage interest deduction. But doing so isn’t always logical.
Before doing too much research, use the 1098 from your mortgage lender to approximate the amount of your interest payments. You are better off choosing the standard deduction because you will pay less in taxes if you don’t have many additional deductions to add to the interest deduction and it isn’t near to $12,950 for single filers or $25,900 for married filing jointly filers.
Questions Regarding Home Equity Loan Interest Deduction
Regarding writing off interest on home equity loans, taxpayers have a lot of questions.
In 2022, is the interest on home equity loans tax deductible?
Home equity loan interest is tax deductible through 2026, according the Tax Cuts and Jobs Act. This implies that if your home equity loan meets IRS requirements and you itemize your deductions, you can write off the interest on the loan.
What Documents Will I Need to Deduct the Interest on My Home Equity Loan?
You’ll need the 1098 forms from your mortgage lender and itemized receipts to show how the money was spent in order to deduct the interest on your home equity loan.
Is the interest on a HELOC tax deductible?
If it adheres to IRS regulations, HELOC interest may be tax deductible. Both a home equity loan and a HELOC have the same regulations. This implies that the loans cannot go over the approved loan amounts, and you must demonstrate that you used the money to purchase, construct, or improve a home.
The conclusion
If the money is spent on the property that served as collateral, borrowers can deduct the interest on their home equity loans. Therefore, you may write off the interest you pay on a home equity loan whether you use it to finance the purchase or construction of a home or to finance upgrades to a home you already own.
