Home Equity Loans and Tax Deductions

[Mar 31, 2009.]

 

One of the primary benefits of a home equity loan or home equity line of credit is the interest paid on that loan can, in many cases, be deducted from federal taxes. The April 15th tax deadline is rapidly approach and it's important homeowners understand when the interest can and cannot be deducted to ensure they get the maximum benefit.

The Internal Revenue Services (IRS) refers to home equity lines of credit and home equity loans as home equity debt if they were taken out for reasons other than to buy, build, or substantially improve a home. If a home equity loan or line was used for one of those reasons and the home acquisition debt limit of $1 million has been exceeded, the excess amount may also be considered home equity debt.

Home equity debt must be secured by the primary residence or second home of the person required to repay the loan. The line of credit or loan must also have been originated after October 13, 1987 or it is considered "grandfathered debt".

Unfortunately, the amount of debt that can be classified as home equity debt is limited to the smaller of $100,000 or the home's fair market value (FMV) reduced by the amount of its home acquisition debt.

For example, a home was originally purchased 5 years ago for $200,000 with an original loan amount (acquisition debt) of $175,000. The current fair market value of the property is $210,000. The permissible amount of home equity debt by the IRS's definition would be $210,000 minus the original $175,000 or $100,000 - whichever is less. In this case, it would be $35,000.

Homeowners that have taken out a home equity line of credit or home equity loan should speak with a tax professional to determine if the interest they are paying on that debt is in fact tax deductible. The interest is then reported on Form 1040, Schedule A, along with other itemized deductions such as real estate property taxes, medical expenses, and charitable contributions.

 

About Author:

Chris Rocks is the Regional Director of the National Credit Federation (NCF), a consumer advocacy group that assists small business owners and consumers overcome debt and credit challenges.