Tax deductions

Guide to home equity tax deductions

Prior to the Tax Cuts and Jobs Act 2017, landlords could claim a plethora of additional tax deductions. But these are no longer an option. After the law was passed, it is more complicated to get a deduction when you borrow against the equity in your home, but it is still possible if you meet certain criteria.

Key points to remember

  • Interest paid on a home equity loan or HELOC may still be tax deductible.
  • Don’t take out a HELOC or home equity loan just for the tax deduction.
  • The high standard deduction means that even those who can claim a home equity tax deduction may not find it beneficial to do so.

Types of home equity

There are two main ways to borrow against the equity in your home. You can take out a home equity loan or a home equity line of credit (HELOC). Both allow you to borrow against the equity in your home, usually at much lower interest rates than other forms of unsecured debt. The choice between the two depends on your current situation, in particular how much money you need over what period. A home equity loan and a HELOC both carry the same risk of foreclosure if you can’t pay them back, or of plunging into the water if your home’s value drops significantly. Home equity loans and HELOCs have the same rules for home equity tax deductions.

Specific tax rules

To qualify for a tax deduction for your home equity loan or HELOC, you must meet certain criteria.

Only the interest on the home equity loan or HELOC can be deducted, and it must be used to “purchase, build, or substantially improve the home of the taxpayer securing the loan.”

The Internal Revenue Service does not explicitly state what counts and what does not count under “buy, build, improve.” If you are unsure whether your expenses will be considered, keep your receipts and consult a tax preparer for specific advice.

In addition to limiting the deduction to certain expenses, the interest deduction is only available for a total loan amount of $750,000. This means that if you claim the mortgage interest deduction for your main mortgage and home equity loan or HELOC, you can only claim interest on a maximum of $750,000 in loan balances combined.

Reduce your tax burden

Leveraging the equity in your home just to cut your taxes may not be the best financial choice. The high standard deduction means you may not even have any tax savings and even if you do you’re paying money to the bank to avoid paying a similar amount to Uncle Sam and erode your home’s equity in the process.

Detail in relation to the standard deduction

In addition to limiting the claim for the mortgage interest deduction, the Tax Cuts and Jobs Act also significantly increased the standard deduction. In 2022, the standard deduction is $12,950 for those filing separately or $25,900 for married couples filing jointly.

This means that for filers who do not already itemize, unless they have particularly high interest rates and loan balances, the standard deduction may result in the highest refund. For those who are already itemizing for other reasons, adding home equity tax deductions can reduce their tax bill.

What is the difference between a HELOC and a home equity loan?

Both a HELOC and a home equity loan use the equity in your home as collateral. A HELOC is a line of credit that allows you to spend, or not spend, up to your limit as needed and repay over time. A home equity loan is a loan for a fixed lump sum on which you make payments at a fixed interest rate over a specified period of time.

How much equity do you need for a home equity loan or HELOC?

Individual requirements vary by lender, but you’ll need a minimum of 75% equity in your home for a HELOC. Most lenders require a minimum of 80% equity for a home equity loan.

How do I calculate the equity in my home?

To calculate the percentage of equity you have in your home, subtract the current balance of any loans you have on your home from the estimated current value of your home. Then divide that number by the value of your home. Here’s how it works with a home worth $400,000 with a loan balance of $300,000.

$400,000 – $300,000 = $100,000

$100,000 ÷ $400,000 = 25%

In other words, this owner has 25% equity.

The essential

The new tax rules still allow you to claim a home equity tax deduction on interest paid on your HELOC or home equity loan as long as you use the money to buy, build or significantly improve the property. that the HELOC or home equity loan is based on. With the increase in the standard deduction, you may not be able to claim the interest paid for the home equity tax deduction unless you go to itemize your return.