Before the Tax Cuts and Jobs Act of 2017, you could deduce home equity home loan interest no matter what you used the funds for. Is home equity loan interest tax deductible since the passage of the TCJA, or are you out of luck?
You can still deduct home equity loan interest so long as you use the cash to “buy, build, or substantially renovate your home” and meet other qualifications. Let’s look at everything you need to know including the limits on loan sizes and how the date you took out your loan impacts your deduction.
The Tax Cuts and Jobs Act of 2017 changed the tax benefits for home equity loan interest, effectively eliminating much of that deduction through the end of 2025. However, a loophole was left by the IRS that permits homeowners to continue deducting home equity loan interest if they meet specific criteria.
There are a number of factors that influence whether you can deduct your home equity loan interest. These include:
On top of that, you will want to consider whether it makes more financial sense for you to take the standard tax deduction or itemize your deductions.
Before you decide that you're going to deduct your home equity loan interest, you'll want to run the numbers and determine whether the standard deduction is more or less than the deductions you can itemize.
You might be wondering why it matters when you took your loan out. The Tax Cuts and Jobs Act (TCJA) of 2017 made it so people that took out their home equity loans after December 15, 2017, can deduct interest on qualified loans. The amount that filers can deduct has to do with whether they file singly or jointly:
If you took out the loan before December 15, 2017, the amount that qualifies for a deduction is higher:
It’s important to understand that these limits also include currently outstanding mortgage loans. For example, if you are filing jointly and owe $500k on your mortgage and you took out your home equity loan after December 15, 2017, only $250k worth of qualified home equity loans can be used for a tax deduction.
In order to be able to deduct the interest on a home equity loan, you must have used the money to “buy, build, or substantially improve” the property that acts as collateral for the loan. This means that if you used the funds to put toward an emergency expense or to pay off debt, you can no longer deduct the interest on this type of loan.
The “buy, build, or improve” rule applies whether you took out the loan before or after December 15, 2017.
If you used part of your loan to buy, build, or improve but the rest of it for another purpose, only the amount that you put towards those qualified reasons is eligible for a tax deduction. For example, if you took out a home equity loan of $300,000 in 2022. You used half of the loan to build a new home office while the rest went to paying off medical bills. Only the $150k you used to renovate your home would be tax-deductible.
It’s important to note that the improvements made with the funds must be on the property that was used to secure the loan. This means that if you took out a home equity loan on your primary residence to pay for improvements to a second home or rental property, the interest wouldn’t be tax deductible.
Unfortunately, the IRS doesn’t give a specific list of which expenses are covered within the “buy, build, or substantially improve the taxpayer’s home that secures the loan” rule. There were a few examples included, however, such as:
If you're currently trying to choose the best avenue for tapping into your home equity, check out our recent post on the pros and cons of interest-only HELOCs.
If you want to deduct your home equity loan interest, there are a number of things you’ll want to keep in mind.
First, you can only take the deduction if you use the money for home improvements or renovations. If you keep the money in your bank for a rainy day or use the money to consolidate credit card debt, it isn’t deductible.
Second, the interest is only deductible if the renovations you make are on the property that is securing the loan. You can’t take out a home equity loan on your personal residence, for example, and use the money to fix up your second home.
Third, it’s important to keep records of all of your expenses. This way, you can back up your claim that you used the money for qualified purposes if you were ever audited. You’ll want to file away bank statements that prove where the money went and receipts for everything.
Finally, you’ll want to remember that this isn’t an unlimited deduction. It’s a good idea if you have both a mortgage and a home equity loan to talk with a tax professional to get a better sense of what you can deduct.
While the new rules about deducing home equity loan interest might sound like bad news for investors, you might be able to still find ways to deduct your loan interest for a rental property or Airbnb property, depending on how you used the funds.
Even though the IRS says:
“You can no longer deduct the interest from a loan secured by your home to the extent the loan proceeds weren't used to buy, build, or substantially improve your home."
They also say:
"You can choose to treat any debt secured by your qualified home as not secured by the home.”
This means that, under interest tracing rules, you might be able to make your interest tax deductible as investment interest, passive activity interest, or trade or business interest.
In order to determine whether you can deduct the interest from your home equity loan on a rental property, it’s a good idea to check with a tax professional. They can help you create a tax structure that offers the greatest benefit as a part of your rental property business.
Are you in the market for a new rental? If so, make sure you use our rental property calculators to help ensure that all of the numbers lean in your favor.