The cost of a home mortgage can often be reduced somewhat by claiming the interest paid as a tax deduction. The same tax benefit of a regular mortgage may also apply to home equity loans. The limitation for deducting interest on a home equity loan depends on how the borrowed funds are used.
Some homeowners choose to take out a home equity loan for home improvements. By doing so, the value of the home may increase by the amount of the home equity loan. Other borrowers may be interested in paying off nondeductible personal debt with a home equity loan. As a result, all home equity must be categorized into one of two categories.
Home equity debt for structural improvements
If the proceeds from a home equity loan are used to make improvements to your personal residence, the interest is deductible in the same manner as regular mortgage interest. For interest to be fully deductible, the combined balance on your primary mortgage and the home equity loan used for improvements must be less than $1 million.
Home equity debt for personal expenditures
There is a separate deduction limit if the proceeds from a home equity loan are not used for home improvements. For example, the separate limitation applies to home equity debt incurred to pay credit cards or buy a car. For such uses, the tax deduction equals the interest paid on the smaller of the two following amounts:
- $100,000 in home equity debt
- The amount of home equity immediately preceding the home equity loan
Your level of home equity is the fair market value of the home reduced by all debts secured by the home. The mortgage deduction limitations are lower if your filing status is married filing separately.
Home equity in two homes
The tax code allows individuals to claim the mortgage deduction for either one or two homes.Consequently, some individuals choose to own a primary home and a vacation home. Regardless of whether a person owns one or two homes, the overall limit on regular mortgage interest remains the same. To determine if interest on home equity debt is deductible, each home must be considered separately.
If used for home improvement, interest on two home equity loans is deducted in accordance with the overall mortgage interest limitations. If not used for home improvements, the difference between fair market value and any existing mortgage debt must be determined for each house. As result, an individual could have two home equity loans. Contact a mortgage specialist for further advice on home equity loans.