Is a Line of Credit Considered Taxable?
Understand how a line of credit impacts your taxes, including whether advances are taxable and when interest payments may be deductible.
A line of credit provides flexible access to funds for personal expenses, home improvements, or business operations. While convenient, borrowers may wonder about potential tax implications.
Understanding how the IRS treats these advances is essential for individuals and businesses alike.
Credit Advances and Taxable Income
Funds drawn from a line of credit are not taxable because they are borrowed rather than earned. The IRS does not classify loan proceeds as income since they must be repaid. This applies to both personal and business credit lines unless the debt is forgiven.
If a lender forgives part or all of a credit line balance, tax consequences arise. Under Internal Revenue Code (IRC) 61(a)(12), canceled debt is taxable unless an exclusion applies. For example, if a borrower negotiates a settlement and a portion of the debt is forgiven, the lender reports the forgiven amount on Form 1099-C, and the borrower must include it in gross income. However, exceptions exist. Under IRC 108(a), taxpayers may exclude canceled debt from income if they are insolvent—meaning their total liabilities exceed their assets—or if the debt is discharged in bankruptcy.
Borrowed funds used for investments can also have tax implications. While the advance itself is not taxable, any returns generated from the investment are. For instance, if a borrower uses a credit line to buy dividend-paying stocks, the dividends are taxable based on whether they qualify as ordinary or qualified dividends. Similarly, if the funds are used to purchase rental property, rental income must be reported, though interest expenses may be deductible.
Interest Deductions for Home Equity Credit Lines
The tax treatment of interest on home equity lines of credit (HELOCs) depends on how the funds are used. Under the Tax Cuts and Jobs Act (TCJA), interest is deductible only if the loan is used to buy, build, or substantially improve the borrower’s primary or secondary residence. Before 2018, interest was deductible regardless of how the funds were spent.
To qualify, the HELOC must be secured by the home, and total mortgage debt—including the primary mortgage and home equity loan—cannot exceed $750,000 for married couples filing jointly or $375,000 for single filers. If total debt exceeds these limits, only a portion of the interest is deductible. For example, if a homeowner has a $600,000 primary mortgage and a $200,000 HELOC used for home renovations, only the interest on the first $750,000 of total debt is deductible.
Proper documentation is essential. Taxpayers should keep records proving the loan proceeds were used for qualifying home improvements, such as contractor invoices or receipts for materials. If funds are mixed with non-qualifying expenses, the IRS may disallow the deduction. Keeping a separate account for HELOC transactions can help maintain clear records.
Business Credit Lines and Deductible Costs
For businesses, the tax treatment of interest and related costs depends on how the funds are used. Under IRC 163(a), interest is deductible if the borrowed money is used for ordinary and necessary business expenses, such as purchasing inventory, covering payroll, or financing equipment. However, if funds are used for personal expenses, the interest is not deductible. Clear recordkeeping is necessary to separate business and personal expenditures.
Businesses with average annual gross receipts exceeding $29 million (adjusted for inflation in 2024) may face limits on interest deductions under IRC 163(j). These businesses can deduct interest only up to the sum of business interest income, 30% of adjusted taxable income, and floor plan financing interest. Smaller businesses are exempt from these limits and can deduct all interest expenses.
Other costs associated with business credit lines, such as origination and commitment fees, may also be deductible. Origination fees are typically capitalized and amortized over the loan term, while commitment fees—paid to secure future access to credit—may be deductible in the year incurred if they qualify as ordinary business expenses under IRC 162.