Can You Still Deduct Your Home Equity Line Of Credit?

If you have a home equity line of credit (HELOC), you may be wondering if you are entitled to a valuable tax deduction for the interest you pay on loan. The rules for the mortgage interest deduction changed, for the worse, under the Trump Tax Plan. Some homeowners who may have been able to deduct their mortgages or HELOCs in the past may no longer be able to capitalize on a deduction for their mortgage interest.

What You Need To Know About HELOC and Taxes

The question of whether or not your home equity line of credit was tax-deductible was confusing enough in the past, but the Trump Tax Plan adds more uncertainty to this popular way to access your home equity. For many of you reading this, your HELOC may provide some tax savings; for others, the interest on your HELOC will not be deductible. To make this dividing line even less clear, some homeowners may find that just a specific portion of their HELOC or second mortgage is tax-deductible. Ultimately, it will depend on your personal mortgage and how you file your taxes.

I work as a financial planner in Los Angeles, and a majority of my clients (across the country) tend to live in areas or cities with relatively high property values. The reduction in the amount of mortgage interest that is allowed to be deducted (both your primary mortgage as well as your HELOC) has been a tax nightmare for many people I have spoken with. Pair this with the $10,000 cap on state and local taxes; you see why so many people were disappointed to see their taxes increase when Trump promised a massive tax cut. The tax plan from Trump did include quite a few limitations on the deduction for HELOCs.

In an effort to help minimize confusion, the Internal Revenue Service (IRS) issued an advisory that can be read here. From the advisory, we get some of the details of what will be deductible and what will not. For the tax years through 2025, you will generally not be able to deduct HELOCs. Like most things in the tax code, there are a few exceptions. If you plan on taking a HELOC deduction, your loan must be used to “buy, build or substantially improve” the residence that secures the underlying loan.

What does or does not qualify for the HELOC Tax Deduction?

If you are using your HELOC loan to improve or purchase your home, you can still potentially deduct the interest. Think of home improvements like replacing the roof, adding solar panels, or remodeling a kitchen or bathroom. I am sorry to tell you that furniture and artwork do not count.

For those of you who are tempted by the record low mortgage rates and plan to use your home like a piggy bank to fund your fabulous lifestyle, you will not be able to deduct the interest on your HELOC. Similarly, using your home equity to fund your children’s college education is no longer tax-deductible. At the end of the day, what you use the money for is up to you. Whether or not that use is deductible is up to the IRS.

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Limits to Home Equity Loan Amounts

Generally, homeowners may deduct interest paid on HELOC debt up to $100,000. But here is some fun, fine print you probably weren’t aware of. The HELOC deduction is limited to the purchase price of the home. This may trip up some of you who’ve owned your home for decades or perhaps bought a real fixer-upper. For example, let’s say you purchased a home for $75,000 and plan to put a ton of work into improvements. In this case, you would only be able to deduct interest paid up to $75,000, if using a HELOC.

Additionally, the Trump Tax Plan limited the mortgage deduction for your first mortgage as well. Beginning in 2018, taxpayers may deduct interest on $750,000 in home loans. This only applies to homes purchased since December 16th, 2017. Homeowners who purchased their homes before that date can still deduct up to $1 million in principal mortgage debt.

Another thing to be aware of is the fact that the $750,000 limit applies to the combined total of all debt on all properties owned. For example, if you have a $400,000 mortgage on your primary residence and owe $350,000 on a vacation home in Palm Springs, the entire amount gets a tax break. But if your primary mortgage is $750,000 and your secondary home is $250,000, you would only get a tax break on $750,000, and none of your paid interest on the second home would be deductible.

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For my single readers, there is a bit of good news here. You can avoid many of the marriage penalties in the U.S. tax code. Two singles could potentially deduct a combined $1.5 million in mortgage debt ($750,000 each) if they went in together on the purchase of a home. A married couple, however, would be limited to $750,000.

Changes to the home equity loans deduction is more likely to hit the average American family. As of writing this post, the median price of a home in the U.S. is $320,000, according to Zillow
Z
. That’s a far cry from exceeding the mortgage deduction limits. I love L.A., but my down payment back in 2007 was almost that much.

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If you find that your head is spinning with all this talk of taxes, you’re not alone. The main takeaway is to be proactive, so you don’t get whacked with a sky-high tax bill when filing in 2020. The good news is that many homeowners across the country will likely take the standard deduction and not have to worry about whether their mortgage or HELOC is tax-deductible. For those with higher income or high mortgage balances, make sure you understand how much, if any, of your HELOC is tax-deductible. Your tax pro or a worthwhile certified financial planner can help you with this.

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