Are home equity loans and HELOC interest tax deductible?

Is a home equity loan or HELOC tax deductible?

Even though home equity loans and HELOCs both let you borrow against any built-up equity you have in a property, these loans don't work exactly the same. Home equity loans offer a lump sum of money upfront and let you pay it back with a fixed monthly payment and interest rate. Meanwhile, HELOCs offer a line of credit you can borrow against (up to limits) with a variable interest rate and a monthly payment that fluctuates based on how much you borrow.

Both types of loans charge interest that can be tax deductible if certain conditions are met. Fred Freifeld, a certified public accountant with Fiske, a firm in South Florida, points to IRS guidelines on deducting home equity interest as the main rules to follow.

To deduct home equity interest on your taxes, the following applies through 2025:

• You must have a home equity loan or HELOC secured by a primary or second home.
• According to the IRS, home equity funds must be "used to buy, build, or substantially improve the residence.”
• Interest on the same debt that's ultimately used to pay for other expenses is not deductible.

The IRS also notes that the rules may be different starting in 2025 if nothing changes.

"For tax years before 2018 and after 2025, for home equity loans or lines of credit secured by your main home or second home, [the] interest you pay on the borrowed funds may be deductible, subject to certain dollar limitations, regardless of how you use the loan proceeds," the IRS writes.

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What are the rules for getting the home equity interest deduction?

Based on the IRS guidelines, understanding when home equity interest can (and can't) be deducted is relatively easy. Essentially, you can deduct interest paid on loan amounts you use to buy, build or improve your property. This could entail a project as big and expensive as adding an addition or garage to your house or undergoing a major kitchen renovation.

However, this rule could also apply if you use home equity funds to add an outdoor deck to your home or upgrade your carpet or kitchen appliances. The IRS states that you must "substantially improve" your home, but this is subject to interpretation.

That said, Freifeld points out that you actually have to itemize when you file your taxes for a home equity interest deduction to apply. This detail is important since the Tax Cuts and Jobs Act (TCJA) increased the standard deduction in 2017. With the standard deduction for American households much higher now than in the past (currently at $29,200 for married couples filing jointly and $14,600 for single filers for the 2024 tax year), fewer people itemize on their taxes than they did before 2017.

How to claim the home equity interest deduction

While the IRS doesn't always report the percentage of Americans who itemize on their taxes each year, its data shows that only 9.3% of all tax returns in 2020 were itemized instead of taking the standard deduction. If you’re part of this minority of taxpayers who itemize, the following steps can help you claim the home equity interest deduction.

Make sure the loan qualifies for a deduction

First, make sure you use the home equity funds to improve your property, per IRS guidelines. Also, note that there are limits on how much home equity loan interest can be deducted in a given year.

The interest deduction cap is set at $375,000 in home debt for married couples filing separately and $750,000 in debt for married couples filing jointly and single filers. Note that higher limitations can apply ($1 million ($500,000 if married filing separately) to mortgage-related debt incurred before Dec. 16, 2017.

Collect documents and receipts

Make sure to gather and organize receipts related to the expenses you're using to justify your home equity interest tax deduction. These could include copies of bills sent to you by contractors, receipts for equipment or supplies, and documentation and receipts supplied to you by home remodeling companies.

Complete paperwork

Finally, you'll want to deduct expenses for home equity interest using Schedule A (Form 1040), line 8a. Once you report the deduction and file your taxes, you should store receipts and other documentation that support your deduction for at least three years.

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Bottom line

Home equity interest may or may not be deductible depending on your situation, and remember that current rules only apply through 2025. Either way, home equity products offer a smart and thoughtful way to borrow money using your home equity. Rates can be low since these loans are secured with collateral, and applying for a home equity loan or HELOC doesn't require you to make changes to your primary mortgage (if you have one).

If you can deduct interest paid on a home equity loan product, the tax savings you'll receive may just be icing on the cake.