Understanding HELOC Interest Tax Deduction

A Home Equity Line of Credit (HELOC) can be a valuable financial tool for homeowners. Not only can it help fund home renovations or consolidate debt at a lower interest rate, but it also offers potential tax benefits. Specifically, you may be able to deduct the interest you pay on a HELOC from your federal income taxes. Here’s what you need to know about the rules for deducting HELOC interest and how to do it.

Rules for Deducting HELOC Interest

The IRS allows the interest on home equity loans and HELOCs to be tax deductible, provided the funds are used to “buy, build, or substantially improve your home.” This means that if you use your HELOC to remodel your kitchen or build an addition, the interest may be deductible. However, if you use the funds for debt consolidation, emergency expenses, or other personal costs, the interest is not deductible.

To deduct your HELOC interest, you must itemize your taxes instead of taking the standard deduction. The rules and limits for deducting HELOC interest can vary based on when you took out your HELOC, your tax filing status, and how you use the funds.

IRS Rules and Limits for HELOC Interest Tax Deduction

Keep in mind, the 2017 tax reform raised the IRS standard deduction substantially, so it may not make sense to itemize your taxes even if you do have HELOC interest you can deduct. In 2024, the standard deduction is $14,600 for single filers and married couples filing separately and $29,200 for married couples filing jointly. Of course, taking the deduction is a smart move if your itemized deductions, including HELOC interest, are higher than the standard deduction amount.

What You’ll Need to Claim the HELOC Interest Tax Deduction

To claim HELOC interest on your income taxes, it’s a good idea to collect some supporting documents, including:

• Mortgage interest statement (Form 1098): Your HELOC lender should send you this form or make it available in your online account dashboard. If necessary, contact your lender to get it before you file your income taxes for the year. You’ll need it to show exactly how much HELOC interest you’ve paid during the year.
• Schedule A (Form 1040): You’ll need this form to itemize the mortgage interest deduction on your tax return. Use Schedule E to deduct interest on your second home if you use it as a rental property, including improvements you make using HELOC funds.
• Proof of eligible expenses: Collect all receipts and invoices that prove you used HELOC funds to buy, build, or improve the home that secured the HELOC. This includes receipts for completed work, materials, labor, and permits. It’s also wise to save your bank statements that prove how the funds were used.

Tax laws change every year, so consult with a tax professional to make sure you have the most up-to-date information and necessary documents.

How to Deduct HELOC Interest on Taxes

If you qualify to deduct HELOC interest on your annual tax return, follow these steps to proceed:

1. Make Sure Itemizing Is Worth It: Add up all of your eligible deductions for the year, such as mortgage interest, property taxes, and charitable donations. Then, assess whether your deductions fall short or exceed the standard deduction, which is up 5% in 2024. Here are the new amounts:
   • Single filers: $14,600
   • Heads of household: $21,900
   • Married couples: $29,200

   If your standard deduction is higher than the total of all your itemized deductions, then it doesn’t make sense to itemize. However, if your deductions are greater than the standard deduction, continue following the steps to deduct your HELOC interest.

2. Gather Your Supporting Documents: As mentioned, you’ll want to gather necessary documents like your Form 1098, Form 1040, receipts, and bank statements. Having the proper documents can help you accurately report your HELOC deduction and may come in handy if the IRS ever audits you. For this reason, it’s a good idea to hold on to your tax return and supporting documents for at least three years.
3. Itemize Your Total Deductions: Once you calculate your total deductions, including your HELOC interest, enter the amount on line 8a of Schedule A (Form 1040).

More Tax Breaks for Homeowners

Deducting mortgage interest is just one of many tax breaks available to homeowners. If eligible, you may also deduct the following:

• Property taxes: State and local property taxes may be itemized as a deduction on Schedule A of Form 1040. The IRS allows a deduction of up to $10,000 for state and local income taxes (less if you’re married and file separately)—including property taxes.
• Discount points: If you purchased points to reduce the interest rate when you bought your home, you can deduct them in the year you took out your mortgage. Similarly, you can also deduct points you pay to lower your rate on a refinance if you use the funds to improve your primary residence.
• Mortgage tax credit: The IRS offers a mortgage credit certificate program to help those with lower incomes afford homeownership. To qualify, you must obtain a mortgage credit certificate before you buy your home. If eligible, you may claim the credit on Form 8396 as part of your home mortgage interest. This credit amount you can deduct varies but is capped at $2,000. Learn more in the IRS Publication 530 (2023), Tax Information for Homeowners.

The Bottom Line

HELOCs deliver many valuable benefits, including lower interest rates than other financing options. They also provide flexible funding when you need it and potential tax deductions if you use the funds to make substantial home improvements. If you itemize your deductions, this benefit could help you save money on your income taxes.

You’ll typically need good credit and adequate home equity to qualify for a HELOC. Before applying, check your credit report and credit score to see where your credit stands and what HELOC rates you may qualify for.

For expert mortgage services and to learn more about how a HELOC can benefit you, contact O1ne Mortgage at 213-732-3074. Our team is here to help you navigate the complexities of home financing and ensure you get the best possible terms for your needs.