When you borrow on your home’s equity, there’s a bonus: The interest you pay each year is often tax-deductible up to a government-imposed limit, the same as on your home mortgage. The rules for claiming that deduction on home equity borrowing are a little different.
The deduction on mortgage interest is dear to Americans and is popularly thought to have been created to encourage middle-class homeownership. In fact, it was implemented along with the federal income tax in 1913. The deduction grew in importance as homeownership became more widespread.
Claim the deduction by itemizing your tax return
Claiming the deduction isn’t difficult. To deduct the interest paid on your home equity line of credit, known as a HELOC, or on a home equity loan, you’ll need to itemize deductions at tax time using IRS Form 1040. That’s worth doing only if your deductible expenses add up to more than the amount of the standard deduction: $12,000 for a single person and $24,000 for a married couple filing jointly in 2018.
Not all home equity loan interest is deductible
The IRS allows interest deductions on up to $750,000 in mortgage borrowing, and that limit applies to the combined amount of all loans secured by a qualifying property — whether they are first (your primary mortgage) or second (home equity) mortgages.
For 2018, you can only deduct the interest paid on home equity proceeds used to “buy, build or substantially improve a taxpayer’s home that secures the loan.”
That’s a big change from prior years, when you could deduct the interest regardless of what you used the money for.
Home equity loans and lines of credit are different products, but the interest deduction rules are the same.
With a home equity loan, you borrow a lump sum over a set period of time at a fixed interest rate. HELOCs are more flexible by comparison. After qualifying to borrow a certain amount, you can take out those funds at any time during the draw period, which usually lasts for 10 years. The interest rate on a HELOC is adjustable, or variable, and follows market rates.
Collect the right tax forms from your lender
Before tax time, you should receive an IRS Form 1098, or the Mortgage Interest Statement, from your lender or lenders. It shows the interest you paid on your primary mortgage, home equity loan or line of credit in the previous year. Call your lender if you don’t get a 1098 or if you want help in understanding it.
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