HELOC Tax Deductions Explained: What Homeowners Need to Know

Oct 8, 2024 | HELOC

Scott Gentry

Written by Scott Gentry

October 8, 2024

A Home Equity Line of Credit (HELOC) is a popular way for homeowners to access their home’s equity for various financial needs. Whether you’re looking to renovate the kitchen, pay for your child’s college tuition, or consolidate high-interest debt, a HELOC can be a flexible solution. But let’s get down to the nitty-gritty—does taking out a HELOC offer any tax benefits? The answer is yes… but with some fine print. If you’re hoping to lower your tax bill, here’s what you need to know about the potential tax benefits of a HELOC.

1. Understanding HELOCs and the 2017 Tax Cuts and Jobs Act: Before we dive into the specifics of tax benefits, it’s essential to understand what changed in 2017. The Tax Cuts and Jobs Act (TCJA) threw a wrench into the HELOC tax deduction party. Before the law was passed, interest paid on a HELOC could be deducted, no matter how the funds were used. You could finance that dream vacation, pay off student loans, or build a rooftop pool, and still deduct the interest.

However, after 2017, the rules tightened up. Now, HELOC interest is only tax-deductible if the loan is used to “buy, build, or substantially improve” the home that secured the loan. So, if you’re planning to use your HELOC for a new hot tub in your backyard, you might still get a deduction. But if you’re using it to pay off your credit card debt, well, you’re on your own when it comes to taxes.

2. When Interest on a HELOC is Tax Deductible: Under current tax laws, HELOC interest can only be deducted if two conditions are met:

  • The funds are used for home improvements. This means the money must go toward things like renovations, repairs, or building projects that increase the value of your home. This includes updating your HVAC system, adding a new bathroom, or putting in energy-efficient windows.
  • The loan is secured by your home. The HELOC must be tied directly to your primary residence (or second home) for you to claim the tax deduction.

Let’s break it down with an example. Suppose you take out a $50,000 HELOC and spend $35,000 on a new roof and $15,000 on a trip to Hawaii. You can only deduct the interest on the $35,000 spent on the roof because the funds were used to improve the home.

3. How Much of Your HELOC Interest Can You Deduct? The tax deduction you can claim is limited to the first $750,000 of total mortgage debt (or $375,000 if you’re married filing separately). This includes your original mortgage and any other loans secured by your home, like a HELOC or second mortgage.

This means if you have a $600,000 mortgage and a $200,000 HELOC, only the interest on $750,000 of the total $800,000 debt is eligible for a deduction. Unfortunately, the taxman doesn’t give you a free pass on all of it.

Home Improvement HELOC
Home Improvement HELOC

4. The Definition of “Substantial Improvement” To qualify for a HELOC interest deduction, your home improvement projects must be considered “substantial.” But what exactly does “substantial improvement” mean?

According to the IRS, these improvements should add value to the home, prolong its useful life, or adapt it to new uses. Some common examples include:

  • Adding square footage with a new room or second story.
  • Installing a swimming pool, patio, or deck.
  • Replacing your roof, plumbing, or electrical systems.
  • Remodeling your kitchen or bathrooms.

On the flip side, minor repairs like painting or fixing a leaky faucet don’t count as substantial improvements and won’t qualify for the deduction.

5. How to Claim the Deduction If your HELOC funds meet the criteria for tax deductibility, congratulations—you’re one step closer to a lower tax bill! Now, here’s how to make sure you claim the deduction correctly.

  • Keep meticulous records. You’ll need to track exactly how the HELOC funds are used. Save receipts, invoices, and any other documentation that proves the money went toward home improvements.
  • Itemize your deductions. You can only claim the interest deduction if you itemize your deductions on your tax return. This is done using Schedule A (Form 1040). If you opt for the standard deduction, you won’t be able to deduct your HELOC interest.
  • Stay under the mortgage debt cap. As mentioned earlier, the total mortgage debt (including your primary mortgage and HELOC) must stay below $750,000 to qualify for the deduction.

6. What About the Deduction for Second Homes? Good news for vacation homeowners! If you have a second home that’s also secured by a HELOC, you can still deduct the interest—as long as the funds are used to improve the second home and not your primary residence. So, that new deck you’re adding to your beach house could still get you a tax break, but only if the improvements are on the home tied to the HELOC.

7. State and Local Tax Considerations: While we’ve been focusing on federal tax law, state and local tax laws may offer additional benefits. Some states provide deductions or credits for home equity loan interest, and these rules can vary widely from state to state. Make sure to check your state’s specific guidelines to see if you’re eligible for any extra deductions.

8. Changes to Tax Laws and Consulting a Tax Professional: Tax laws are complex, and they can change quickly—so even if you’re an Excel wizard, it’s a good idea to consult a tax professional. They can help you figure out exactly how much of your HELOC interest is deductible and ensure you’re staying compliant with the latest IRS regulations. After all, you don’t want your home improvement deduction dreams to come crashing down because of a mistake on your return.

Conclusion: In conclusion, while the tax benefits of a HELOC aren’t as broad as they once were, there are still opportunities to save money—if you play by the rules. By using your HELOC funds for home improvements, keeping your mortgage debt within limits, and itemizing your deductions, you can still enjoy some valuable tax perks. Just remember to track your expenses carefully, keep up with changing tax laws, and seek advice from a professional when necessary.

Thinking of taking out a HELOC? Make sure you weigh the tax implications before signing on the dotted line. Your wallet—and your home—will thank you! If you’d like to learn more about HELOCs, check out our sister site HELOC Learning Center.

Scott Gentry
Author: Scott Gentry

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