Are home equity loans tax deductible?

You have a big remodel on the horizon and you're considering a home equity loan. That's smart, since home equity loans can help you afford big expenses with a competitive rate. And if you're going to use that loan to make improvements to your home, it could come with a tax break, too.

Yes, you may be able to deduct the interest from your home equity loan at tax time. How you use the loan matters, though.

Home equity loan interest may be tax-deductible if: 

• Loan proceeds are used to buy, build, or substantially improve the home that secures the loan 

• You itemize deductions 

• You stay within IRS mortgage interest limits. 

Interest on borrowed money that’s used for expenses like debt consolidation, tuition, or travel isn’t deductible.

We'll go over the basics of home equity loan deductions in this guide, but we're not tax experts. Consulting a tax professional is the best way to determine if your home equity loan qualifies for any deductions in your situation.

Are home equity loans tax-deductible?

The interest you pay on mortgage debt could be deducted from your federal income taxes under certain conditions, per the IRS. This rule applies to mortgage interest from your primary home loan plus any second mortgages, like a HELOC or home equity loan.

Great, but what's that actually mean? First, a deduction is a way to lower your taxable income. For example, if you earned $10,000 and you have a $1,000 deduction, you may only have to pay taxes on $9,000.

This particular deduction is for the interest you paid on your mortgage debt in that tax year. The lender should send you an annual statement that gives you the exact dollar figure. As for the conditions you need to meet, let's take a deeper dive.

When home equity loan interest may be deductible

The IRS only allows you to deduct home equity loan interest under certain conditions. You don’t need to be a legal pro to understand how it works, though. Here’s a quick summary:

• You must be listed on the home’s title.

• You must use the funds on the same home that secures the loan.

• You must itemize your deductions, rather than taking the standard deduction.

• You must use the funds to build, buy, or substantially improve the home. That means things that increase your home’s value, lengthen its useful lifespan, or modify it for new living uses.

Additionally, there's a cap on how much you can deduct. The interest paid should be on no more than $750,000 of mortgage debt ($375,000 for single tax filers). This includes your home equity loan or HELOC and your first mortgage if you have one. If your total mortgage debt is more than $750,000, you could still deduct the interest you paid on the first $750,000.

When home equity loan interest is not deductible

You can’t deduct home equity loan interest if it doesn’t meet the list of criteria above. Here are some common examples:

• You take the standard deduction. Unless you have a lot of other tax deductions to list out, it’s often better to take the standard deduction, which most people do. In that case, the whole point of whether you can deduct home equity loan interest or not is moot. 

• You use the funds to buy a second home. You can use home equity loan funds for whatever you want, but unless you’re spending it on the same house that secures the loan, you can’t deduct the interest. 

• You use some of the funds to send your child to college. If only some of your loan proceeds go to upgrading your house and you spend the rest on other things, you can still deduct the interest. Only on the portion of your loan that you spent on your eligible home upgrades.

• You pay to paint the interior and exterior walls of your home. Painting your home isn’t enough to qualify as a  home improvement that boosts your value, according to IRS guidelines. It needs to be something substantial, like remodeling your kitchen.

• Your home loan debts exceed $750,000 ($375,000 for single filers). You could still deduct some of the interest if you owe more than $750,000 across your mortgage and HELOC. You typically can’t deduct interest on any debt balances over that limit. 

How is a home equity loan similar to a mortgage?

A home equity loan is a type of mortgage. If you already have a mortgage from buying your home, the home equity loan would be your second mortgage. Both types of mortgages may let you deduct loan interest from your federal taxes under the conditions described above. 

Here are some of the other ways the two loans are similar:

• Both are secured loans that use your home as collateral.

• If you don't make your payments, either could result in foreclosure.

• Homeowners insurance is required to get the loan.

• Your credit, income, and debt-to-income (DTI) ratio will need to meet the lender’s requirements

• You can get a fixed interest rate with equal payments over the life of the loan

• A professional appraisal or digital valuation is required to determine the current market value of the home

In case it’s been a while since you got a mortgage, your DTI is the percentage of your income that goes toward debt payments, including your housing expenses. In general, lenders want you to have a DTI of 43% or less.

How is home equity loan interest different from mortgage interest?

Mortgage interest is always a potential tax deduction because a mortgage is always used to purchase the home that you borrowed for. In contrast, since home equity loans can be used in many other ways, the interest doesn’t always qualify for the tax deduction.

For this reason, if you’re considering a remodeling project, borrowing against your home could save you money compared with taking a personal loan, which isn’t tax-deductible at all. Also, home equity loan rates are usually lower than for personal loans. 

Do you need to itemize to deduct home equity loan interest?

Yes, you have to itemize to get the deduction for home equity loan interest. This is typically done using Form 1040, Schedule A. Don't worry, though; filling out the form is fairly straightforward.

Itemizing could lower your tax bill if, when you add up all of your deductions, the total is greater than the standard deduction for that tax year. The standard deduction is the base amount the IRS allows you to automatically deduct without itemizing. 

Even with home equity loan interest, the standard deduction could save you more money than itemizing if you don't qualify for many deductions. Consult a tax professional to discuss the best route for your situation.

What forms do you need for the home equity loan tax deduction?

Keep all the important loan documents, as well as any documents that prove how you used the home equity loan. This includes:

• Loan statements showing how much you borrowed

• Receipts, contracts, and other documents showing how the funds were used

• Form 1098, the Mortgage Interest Statement, from your lender showing interest payments. You’ll get separate 1098s for your mortgage, if you have one, and your home equity loan.

Are HELOCs tax-deductible too?

Yes, the interest from HELOCs could be tax-deductible. The IRS treats a HELOC the same as a home equity loan. That means all the same rules and restrictions about deducting your home loan interest apply to a HELOC, too. 

The deduction depends on how the funds are used, not whether the loan is a HELOC or a lump-sum home equity loan. The difference between a HELOC vs. home equity loan is how they’re set up: one is a lump-sum loan, and the other is a line of credit.

How to know if your home equity loan interest qualifies

It's smart to consult a tax professional if you're not sure what will qualify for a home equity loan interest deduction. But here's a quick questionnaire to help you get a rough idea of your potential eligibility:

• Are you itemizing your taxes? If you take the standard deduction, you can’t claim a deduction for home equity loan interest, too. 

• Are you one of the homeowners? You can only deduct home equity loan interest if you’re listed on both the loan itself and on the home’s title.

• Are your combined home debts $750,000 or less? If you’re a single filer, you can only deduct the interest you pay on $375,000 worth of home debts, if you bought your home after 2017. 

• Are you upgrading the same home the loan is tied to? If you use the loan for work on another property you own, like digging a well at your camping hideout, it won’t count.

• Are you using the funds to substantially upgrade your home? In order to qualify, the upgrade needs to boost your home’s value, lengthen its useful lifespan, or adapt it for new ways of living. Regular home maintenance and repairs don’t count. 

If you could say yes to all of the questions, your home equity loan interest could qualify for deduction.