Is home equity line of credit (HELOC) interest tax deductible?

When is HELOC interest tax deductible?

The interest you pay on borrowed funds from a HELOC may be tax deductible (up to certain dollar limitations) if you use the HELOC to buy, build, or substantially improve the residence that secured the loan. The interest may only be tax deductible if paid on the portion of the loan that's used for these purposes.

Say you take out a $10,000 HELOC and use $5,000 of it to pay off credit card debt and $5,000 to substantially improve your home. You may only be able to deduct the interest on the $5,000 used to substantially improve your home.

The IRS says that a home improvement is "substantial" if it adds to the value of your home, prolongs your home's useful life, or adapts it to new uses. For example, repairs that maintain your home, such as repainting, aren't considered substantial improvements. However, painting as part of a renovation that significantly enhances your home may be considered a substantial improvement. 

Consult a tax advisor to learn more about which home improvements are considered substantial.

How to claim a HELOC tax deduction

First, you need an IRS Form 1098 (Mortgage Interest Statement) from your lender. This form lists the amount of interest you paid on your HELOC in the previous year. It's a good idea to keep documentation showing how you used your HELOC loan funds, such as receipts and invoices, in case the IRS ever asks for it.

If eligible, you can deduct the interest you paid on your HELOC by itemizing it alongside any other deductions on Schedule A (IRS Form 1040), line 8a.

If you have any questions, speak with a tax professional.

Other advantages of HELOCs

Depending on your circumstances, HELOCs may offer several advantages over other loans.  Unlike loans disbursed in a lump sum, a HELOC allows borrowers to access funds as needed, which may make it a convenient option for unexpected expenses or emergencies.

Also, you may use HELOCs for various purposes, such as home improvements, debt consolidation, or property investment. 

Home equity loans vs HELOCs

Home equity loans and HELOCs are both ways to borrow money against the value of your home. However, there are some key differences between the two. 

A home equity loan provides a lump sum of money, typically with a fixed interest rate.

A HELOC, on the other hand, allows you to borrow money as needed up to a predetermined limit during the initial phase of the loan, which is called the “draw period.” The interest rate on a HELOC is usually variable, and you may only be required to pay interest during the draw period. After that, you normally enter a repayment period where you pay interest and the loan principal.

Both loans can be helpful in different situations. For example, a home equity loan may be the better option if you need a large sum of money all at once. A HELOC may be best if you need ongoing access to funds over a longer period.

Whether you have a home equity loan or a HELOC, interest may be tax deductible if the loan meets certain requirements.

READ MORE: HELOC vs Home Equity Loan: Which is Right for You?