Is a HELOC Taxable Income? What You Need to Know
Understand the tax implications of HELOCs, including when funds are taxable and how interest deductions work. Learn about documentation for tax filings.
Home Equity Lines of Credit (HELOCs) allow homeowners to borrow against the equity in their homes. Understanding the tax implications of HELOCs is crucial for borrowers to make informed financial decisions.
Many borrowers question whether accessing HELOC funds affects their taxable income. This article explores when HELOC funds may be taxable, the implications of canceled or forgiven debt, interest deductions, and the documentation required for tax filings.
When Are HELOC Funds Taxable
Funds drawn from a HELOC are not considered taxable income because they are loans that must be repaid. However, under the Tax Cuts and Jobs Act of 2017, the interest on HELOCs is deductible only if the funds are used to buy, build, or substantially improve the home securing the loan. If the funds are used for purposes like paying off credit card debt or funding a vacation, the interest is not deductible, although the funds remain non-taxable.
If a lender forgives a portion of the HELOC debt, the forgiven amount may be taxable as it constitutes a financial benefit to the borrower. Unless exclusions such as insolvency or bankruptcy apply, the IRS requires the forgiven debt to be reported as income.
Canceled or Forgiven HELOC Debt
Canceled or forgiven HELOC debt is generally treated as taxable income by the IRS. The Mortgage Forgiveness Debt Relief Act, enacted in 2007, allowed certain forgiven mortgage debt to be excluded from taxable income, particularly for principal residences. However, this exclusion does not broadly apply to HELOCs unless the funds were used for home acquisition or improvement. If the forgiven debt does not qualify for these exclusions, it must be reported as income.
Taxpayers may qualify for exclusions like insolvency, which occurs when liabilities exceed assets. To determine eligibility, taxpayers should calculate their total assets and liabilities immediately before the debt cancellation. If they qualify, Form 982 must be filed with the IRS to exclude the forgiven amount from taxable income.
Interest Deduction and Requirements
Interest paid on HELOCs is deductible only if the funds are used for home acquisition or significant improvements, as specified by IRS guidelines. Homeowners should retain detailed records of how HELOC funds are used, including invoices, receipts, and contracts for home improvements, to substantiate their claims with the IRS.
The deduction is capped at $750,000 in total mortgage debt for married couples filing jointly or $375,000 for single filers. This limit includes both primary mortgages and any additional home equity loans. Taxpayers must ensure their total mortgage debt remains within these thresholds to fully benefit from the interest deduction.
Documentation for Tax Filings
Accurate documentation is essential for tax filings involving HELOCs. Taxpayers should maintain a detailed record of all HELOC transactions, including disbursements and payments, clearly identifying the purpose of each transaction, particularly if the funds are used for deductible home improvements.
Form 1098, issued by lenders, reports mortgage interest paid during the year, including HELOC interest. Taxpayers should verify the accuracy of the information on this form and address any discrepancies with the lender promptly to avoid complications during IRS reviews. Maintaining organized records ensures compliance and smooth tax filing.