Using a home equity line of credit, or HELOC, comes with the cost of paying back interest in addition to the amount you borrow. This may leave you wondering, is HELOC interest tax deductible?
The short answer is: Sometimes.
With a traditional first mortgage, the interest you pay on it can be deducted if you itemize deductions on your tax return. For a HELOC, it largely depends on the tax year and what you use the proceeds for.
What Is a HELOC?
A HELOC is a cross between a home equity loan and a credit card. You can break down the terminology into two sections: “home equity” and “line of credit.”
Similar to a mortgage or home equity loan, you’re borrowing against the equity you own in your home with a HELOC. Your home is used as security for the lender, which means you’ll be able to get a lower interest rate than you would with an unsecured line of credit or personal loan.
Line of Credit
When you take out a loan, you borrow a lump sum of money, usually for a fixed interest rate. A line of credit, however, means that you’ve applied with a lender to have access to funds up to a maximum amount at a variable interest rate (like the credit limit and the annual percentage rate, or APR, on a credit card).
So how does a HELOC work? A HELOC provides a draw period, which is a specified amount of time you have to use the available funds. You can draw money up to the max, repay it, and keep drawing on it until the repayment period sets in. At that time, you’ll begin repaying the principal and interest over a set number of years.
Tax Deductibility of HELOC Interest
The federal government uses tax laws and breaks to encourage behaviors such as saving for retirement, donating to charity, and owning a home.
If you itemize deductions on a tax return, you’ll see a section that asks for the amount of interest paid on a mortgage. A home equity loan or HELOC is another layer of homeownership cost, and in most years the IRS has allowed that loan interest to be deducted.
The Tax Cuts and Jobs Act and Its Impact on HELOCs
In the original language of the Tax Cuts and Jobs Act (TCJA) passed on December 22, 2017, homeowners were dismayed to see that the interest on home equity loans and HELOCs was no longer deductible.
However, the IRS issued an advisory memo in February 2018 to inform taxpayers that they could still deduct the interest if the HELOC or home equity loan proceeds were used to “buy, build or substantially improve the taxpayer’s home that secures the loan.”
Since the TCJA’s changes aren’t permanent, deductions for qualifying home equity indebtedness interest are limited based on the tax year. Claims in tax years:
- 2017 and before are allowed regardless of how the proceeds are used
- 2018 through 2025 are only allowed to buy, build, or substantially improve a home
Conditions for Tax Deductibility of HELOC Interest
For HELOC interest tax deduction, you’ll need to meet a few more conditions. The debt must be:
- Taken on your primary home or a second home
- Secured by a qualifying residence that has sleeping, cooking, and toilet facilities
- Used for residential living (vs. business use of home) improvements
Additionally, the sum total of all home-secured debt (primary mortgage, HELOC, and home equity loans) cannot exceed:
- $750,000, or $375,000 if married filing separately (MFS)
- $1 million ($500,000 MFS) for debt incurred between October 13, 1987, and December 15, 2017
Limitations on HELOC Interest Deduction
The biggest hoop to jump through is how the money is spent.
You can take out a HELOC for any purpose and use the money as you choose. However, the interest deduction is only allowed if you use the HELOC for improvement on the property that secures the line of credit.
You can’t take a tax deduction on the loan interest if you use it for any other purpose, such as:
- Paying off credit card or other debt
- A down payment for another property purchase
- Repairs to a rental property
- Education or medical costs
How to Claim a HELOC Interest Deduction
A HELOC interest tax deduction is claimed as part of itemizing your deductions on Schedule A of Form 1040 or 1040-SR. Prior to the 2017 Tax Cuts and Jobs Act (TCJA), most homeowners opted to itemize deductions.
However, the TCJA increased standard deductions to the point that many homeowners find it more beneficial to go standard rather than itemize. For tax year 2023, the standard deduction is $13,850 for single filers and $27,700 for married couples filing jointly.
Determining if Your HELOC Qualifies for Interest Deduction
If it makes sense for you to itemize, start by adding up your outstanding debt secured by your home on the 1098 forms (Mortgage Interest Statement) you receive from your mortgage, HELOC, and home equity lenders.
Make sure your home-secured debt doesn’t exceed the totals in the “Conditions for Tax Deductibility of HELOC Interest” section above, after calculating the residential vs. business use split of your home if applicable.
Next, ensure your debt was used for qualifying expenses.
How to Use HELOC Funds for Qualifying Expenses
A HELOC can be used to purchase, build, or substantially improve the qualifying home that’s used to secure the loan. For most borrowers, “substantially improve” will be the goal—so what exactly does that mean?
According to the IRS, substantial improvement should meet one or more of these qualifications:
- It adds to your home’s value
- It prolongs the useful life of the home
- It adapts your home to a new (non-business) use
There is no comprehensive list of qualifying projects, but examples given by the IRS include:
- Building a new addition
- Roof replacement
- HVAC replacement
- Major kitchen or bathroom remodel
- Driveway resurfacing
Maintenance and minor repairs and cosmetic changes don’t typically cut it, although they can be built into a larger project. For instance, repainting a room alone doesn’t qualify, but repainting as part of a major renovation does.
Documentation and Receipts for Your Home Renovation Project
You’ll need your loan and spending information to file for a HELOC interest deduction.1 In addition to the 1098 forms sent by your lender, protect yourself from an audit by gathering up contracts, invoices, receipts, and bank statements related to:
- Building materials
- Architect and design plan fees
- Required building permits
The Benefits and Risks of Taking Out a HELOC
With these limitations and conditions, is a HELOC a good idea?
On the bright side, a HELOC provides:
- Lower interest rate than unsecured credit card debt or personal loans
- Funds to use as you choose (but without an interest deduction for nonqualifying use)
- The opportunity to only take out what you need instead of accepting a lump-sum loan
Risks and costs of HELOCs include:
- The risk of losing your property to foreclosure if you don’t meet repayment obligations
- Significant total interest costs due to variable interest structure and current higher rates
- Slightly higher rates than for refinancing or traditional home equity loans
How a Sale-Leaseback Can Be a Better Option
HELOCs come with variable interest rates, which are on the rise and expected to stay that way with the recent rate hike announcement by the Federal Reserve. The average as of August 7, 2023, is 8.74%, up from just over 4% in early 2022.
That means paying total interest that could equal more than the amount you borrow over the course of a 10-year-draw, 30-year-repayment HELOC. Even if you qualify for a tax deduction, and even with the lower-than-unsecured-debt interest rate you’ll receive for a home-secured credit line, there is a significant cost to this credit line.
A sale-leaseback program (SLB) may be a better option if your goals are to:
- Leverage your home equity to obtain cash
- Use that cash at your discretion for any purpose
- Avoid a home sale that means having to move out
Rather than a loan, an SLB combines a home sale with a right of residency. You sell your property to an investor-landlord, and at closing you’ll also sign a lease agreement and a contract that provides you the legal right to continue living as a renter in your home for as long as you choose.
In addition to a cash payout from the sale, you’ll no longer have to pay homeowner’s insurance, property tax, and repairs and maintenance
HELOC interest is tax deductible under certain circumstances, and you’ll need to itemize your deductions rather than claiming the standard deduction to make it happen.
For tax years 2018 to 2025, the line of credit has to be taken on a primary or second home, and the proceeds have to be used for substantial improvement to the same property used to secure the credit. The projects must increase property value, prolong a property’s life, or adapt it to new use.
There are also limits on total equity debt for which interest is deducted ($750,000, or $375,000 MFS).
For some homeowners, a sale-leaseback program that converts your equity to cash is worth investigating as an alternative to taking on new debt.
- Nerdwallet. Are Home Equity Loans Tax-Deductible? https://www.nerdwallet.com/article/mortgages/home-equity-loans-tax-deductible
- Investopedia. How the TCJA Tax Law Affects Your Personal Finances. https://www.investopedia.com/taxes/how-gop-tax-bill-affects-you/
- IRS. Interest on Home Equity Loans Often Still Deductible Under New Law. https://www.irs.gov/newsroom/interest-on-home-equity-loans-often-still-deductible-under-new-law
- IRS. Publication 936 (2022), Home Mortgage Interest Deduction. https://www.irs.gov/publications/p936
- IRS. Topic No. 505, Interest Expense. https://www.irs.gov/taxtopics/tc505
- Investopedia. Is Interest on a Home Equity Line of Credit (HELOC) Tax Deductible? https://www.investopedia.com/mortgage/heloc/tax-deductible/
- Investopedia. Tax Loophole for Deducting Home Equity Loan Interest. https://www.investopedia.com/taxes/tax-loophole-found-homeequity-loan-interest/
- Bankrate. Best home equity line of credit (HELOC) rates for August 2023. https://www.bankrate.com/home-equity/heloc-rates/
- Good Calculators. HELOC Payment Calculator. https://goodcalculators.com/heloc-payment-calculator/