Most people who itemize their taxes can deduct the interest they pay on home equity loans and home equity lines of credit. This can lead to significant savings at tax time. For example, someone with a home equity loan of $50,000 to be repaid over 15 years at 6 percent interest would be able to deduct $2,942.31 of interest payments the first year.
Itemize Deductions
Interest paid on home equity loans counts as a tax deduction only for people who itemize their tax deductions. People who take the standard deduction are not allowed to deduct home equity loan interest in addition to the standard deduction. However, many homeowners already itemize deductions because interest paid on the mortgage is also tax deductible. Itemize deductions by listing them on Schedule A of Form 1040.
Dollar Limit
Taxpayers can deduct only the interest paid on the first $100,000 of home equity debt, or the first $50,000 if married filing separately. However, the home equity loan counts as if it were an additional first mortgage if it is used to make improvements to the home that increase the home's value. This means that interest on home equity loans larger than $100,000 can be fully deductible if the loan was for improvements and the total mortgage for the home is less than $1 million.
Additional Restrictions
The home equity debt must be on the homeowner's first or second home to qualify for the personal tax deduction. Home equity debt on a property that the homeowner rents out must be listed as a business expense instead. In addition, if the sum of the home equity loan balance and the mortgage loan balance is more than the current market value of the home, not all of the interest is deductible. For example, a homeowner who owes $140,000 on a home with a market value of $170,000 can only deduct interest on the first $30,000 of a home equity loan.
Significance
The tax deduction on home equity loan interest makes these loans especially appealing as alternatives to other types of loans or credit. Most types of consumer debt, including auto loans and credit card debt, are not tax deductible. However, consumers can take out a home equity loan and use the money to pay off credit cards, auto loans or make any other kind of purchase. This makes it possible to deduct the interest on taxes.
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