Is Interest on a Home Equity Loan Tax Deductible?
The tax deduction for home equity loan interest is now conditional. Learn how the use of the funds and other factors determine your eligibility under current law.
A home equity loan allows a homeowner to borrow against the equity in their property. The interest paid on these loans was once broadly deductible, but the Tax Cuts and Jobs Act of 2017 (TCJA) introduced new limitations. These changes mean that the deductibility of interest now depends on how the loan proceeds are used and the total amount of mortgage debt a homeowner carries.
Rules for Deductibility
For interest on a home equity loan to be tax-deductible, it must meet requirements established by the Internal Revenue Service (IRS). The primary requirement is the “use test,” which dictates how the loan funds are spent. The proceeds must be used to “buy, build, or substantially improve” the qualified home that secures the loan, meaning the loan must function as acquisition indebtedness.
A substantial improvement is one that adds to the value of your home, prolongs its useful life, or adapts it to new uses. Examples of qualifying improvements include adding a new bedroom or bathroom, remodeling a kitchen, replacing a roof, or installing a new HVAC system. Conversely, funds used for simple repairs, routine maintenance like painting, or personal expenses are not eligible. Using a home equity loan to pay off credit card debt, cover tuition costs, or purchase a vehicle will render the interest non-deductible.
Beyond how the money is used, the deduction is subject to a debt limit. For tax years 2018 through 2025, a taxpayer can only deduct interest on a total of $750,000 of qualified residence loans. This cap is lowered to $375,000 for those who are married but file separate tax returns. This limit applies to the combined total of all loans secured by your home, including your primary mortgage and any home equity loans. For example, if you have a $600,000 mortgage and take out a $200,000 home equity loan for an addition, you can only deduct the interest on the first $750,000 of the total $800,000 debt.
The loan must also be secured by a “qualified home.” The IRS defines a qualified home as either your main home or a second home. A main home is the one you live in most of the time, while a second home can be any other residence you own and treat as a second home. The property must have sleeping, cooking, and toilet facilities to qualify. The debt must be formally secured by the property, meaning a mortgage, deed of trust, or similar legal instrument is recorded.
Required Documentation and Information
Properly claiming the home equity interest deduction requires record-keeping to substantiate your eligibility to the IRS. The primary document you will receive is Form 1098, the Mortgage Interest Statement. Your lender is required to send you this form if you paid $600 or more in mortgage interest during the year, and it reports the total amount of interest you paid.
While Form 1098 provides the total interest paid, it does not prove how you used the loan proceeds. You must maintain your own comprehensive records that trace the funds from the loan directly to the qualifying home improvements. This documentation serves as your proof should the IRS question the deduction.
Examples of proof include detailed invoices from contractors that describe the work performed, receipts for building materials and supplies, and copies of any building permits required for the project. Signed contracts with architects, builders, and other professionals involved in the renovation are also important. Without this proof of use, the deduction may be disallowed upon examination.
Claiming the Deduction on Your Tax Return
The deduction for home mortgage interest is an itemized deduction, which means you cannot claim it if you take the standard deduction. Taxpayers must choose between itemizing deductions or taking the standard deduction, a flat-dollar amount that varies based on filing status, age, and other factors. You should calculate your taxes both ways to see which option results in a lower tax liability.
If itemizing is more beneficial, you will report the deductible interest on Schedule A (Form 1040), Itemized Deductions. The total interest you paid for the year, as reported by your lender on Form 1098, is entered on line 8a of this schedule. It is your responsibility to ensure that the amount you claim adheres to all IRS rules.
You do not need to submit your proof-of-use documents, such as receipts and contracts, with your tax return. However, records related to home improvements must be kept for as long as you own the property, plus three years after you sell it. These records are needed to verify the deduction and to figure the gain or loss when you eventually sell the home.