The 2023 tax deduction eligibility for home equity credit lines is a critical point for consumers looking to maximize homeownership benefits. If you own your home, you probably have noticed that real estate prices have climbed significantly in the last year. For some homeowners, they may be enjoying 25% or more of home price increases since the pandemic started.
If that has happened in your area, you may be thinking about pulling equity out of your home with a home equity line of credit or HELOC.
This second mortgages allows you to tap some of your equity to use on things you need, such as improve your home, pay for college education, or start a business. Some people also use the loan to pay off credit cards.
However, if you plan to get a HELOC and pull-out equity, what are the tax implications? The IRS has been making changes to tax laws in recent years, so what’s going to happen with HELOC interest for 2024?
IRS Tax Rules for HELOC Interest For 2023
The IRS has stated several times since 2018 that taxpayers can often deduct the interest, they pay on home equity loans and lines of credit. The home equity tax deduction rules include itemizing deductions and using the home equity loan or HELOC to buy, build, or improve your home. The interest on the home equity lines may also be tax-deductible under the same rules.
In most cases, you can claim a tax deduction for the interest you pay on up to $750,000 of home equity loan debt with any filing status except married filing separately. In that case, you can only deduct interest on up to $375,000 of home mortgage debt.
These limits went into effect for loans taken out on or after December 16, 2017 as part of the federal Tax Cuts and Jobs Act (TCJA). The HELOC interest tax deduction will expire on the last day of 2025, unless the U.S. Congress extends the date beyond.
The Tax Cuts and Jobs Act of 2017, however, did suspend the interest deduction on HELOCs and home equity loans, UNLESS homeowners use them to make improvements on the home.
Under the new IRS rules, interest on a HELOC-loan that was taken out to add a room to an existing home is usually deductible. But interest on a home equity loan to pay for college tuition isn’t deductible.
As under the earlier law, the home equity loan or home equity line of credit must be secured by the homeowner’s primary residence.
New Dollar Limits
If you are thinking about taking out a second mortgage, the new IRS law has a lower dollar amount on mortgages that qualify for the mortgage interest deduction.
Starting in 2018, taxpayers are only allowed to deduct mortgage interest on $750,000 of residence loans. And the limit has been set at $375,000 for a taxpayer who is married and filing a separate return.
These amounts have been reduced from $1 million and $500,000 for a married homeowner filing a separate tax return.
The new limits are applicable to the combined dollar amounts of loans that are taken out to build, buy or improve the home and second home. Lear more about tax deductions for home equity loans in 2024.
Examples Of How Much HELOC Interest You Can Deduct
As noted above, if you’re married and filing a joint return, you only can deduct interest on $1 million or less of home debt, and $100,000 or less of home equity debt.
If you are filing separately, the limits are $500,000 for home debt and $50,000 in home equity debt. So, if your mortgages are taken out to buy, build, or improve a first or second home and the total is $1 million, you are allowed by the IRS to deduct all the interest. For instance, if you have an interest rate of 4% on two mortgages that total $1 million, you are allowed to tax deduct your yearly interest payments of $40,000. But if you have $2 million in home debt, you only are allowed to deduct 50% of the interest you paid on the $2 million of mortgages.
If you have a 4% interest rate, you only are allowed to deduct $40,000 instead of $80,000. The limit does not apply to legacy debt, but you cannot deduct more interest if the legacy debt is already more than $1 million. So, if you have $900,000 in legacy debt, you only are allowed to write off interest for $100,000 of home debt.
Also key in understanding how much mortgage debt you can write off on second mortgages is when you took out the loan. If you took it out before December 16, 2017, you are allowed to deduct interest on up to $1 million of mortgage debt if the mortgage is used to buy, build or improve your home.
However, having one loan that has been grandfathered does not make other loans the same status. For instance, if you owe $800,000 on a loan that was taken out in 2016, you are not allowed to take out another loan for $200,000 this week and deduct mortgage interest on the entire $1 million. Get up to speed on the latest home equity financing opportunities, see HELOC versus Home Equity Loan.
What Are the Most Important Home Improvements?
Now that you understand what the IRS rules deducting interest on a second mortgage, let’s look at the improvements that are best for your wallet:
- Wood deck: When you add something to the outside of the home that makes it more usable, it’s usually a good investment of your home equity dollars. A deck is a great addition, and it can really add value to your home if you choose wood, with an estimated 82% ROI.
- Kitchen: When people are considering buying a home, they usually check out the kitchen first. It also is one of the first things people consider when making an offer because they would rather not have to spend money on upgrading the kitchen. But you don’t have to spend tens of thousands of dollars on a high-end kitchen to get a good ROI. A minor upgrade including flooring, counters, and cabinets may return 80%, but a major upgrade only gives you 50% back.
- Siding replacement: If your home is more than 10 years old, the siding may date your home and not in a good way. But upgrading the siding of the home can be a good choice with about a 76% ROI assuming you replace 1200 square feet of siding. While you’re doing that, you also should think about replacing your OEM vinyl windows that can reduce your electric bills by 20% per month or more.
Under the IRS rules for deducting any kind of home loan interest, a “qualified home” may be your main home (primary residence) or second home (perhaps a vacation home, but only if you don’t rent it out). The IRS tax rules can be complex, but the recent changes to the home interest deduction for second mortgages can still save you a lot of money when you decide to make improvements on your home.
You should talk to your CPA if you have questions about how much you’re allowed to deduct.