Using Home Equity? Don't Forget These Important Tax Implications

Whether it's a home equity loan or line of credit, home equity is a valuable resource for you to lean into as a homeowner. There are several ways in which you can use the funds because of your equity, and the benefits don't stop with that variety. You can also receive significant tax advantages depending on how you're using the home equity funds.

Let's look at how you can maximize the tax benefits offered by home equity loans and lines of credit, as well as what to look out for and how to apply for these advantages.

Reviewing Home Equity Loans and HELOCs

Before we review the tax benefits that can come from home equity products, let’s review what home equity loans and lines of credit are. A home equity loan is a loan where the security, or collateral, is your home itself. The loan amount you’ll be approved to borrow is determined by the amount of equity you’ve built up in your home and by your lender.

A home equity line of credit, commonly called a HELOC, follows the same concept. The major difference is that a HELOC is a line of credit, where you can borrow portions of your approved credit line instead of the entire sum. With a home equity loan, you’ll receive the funds in one lump sum. Both a home equity loan and a HELOC use your home as collateral for the funds.

Home equity itself is the portion of your home that you own outright and have paid off your mortgage. Say your home's current value is $350,000 and you still owe $150,000 towards your mortgage. You would subtract these two values, leading to you having $200,000 equity in your home. From here, your lender will determine how much you’re approved to borrow for a home equity loan or line of credit.

Tax Advantages of Home Equity Products

There may be tax benefits you can take advantage of when it comes to your home equity. Your eligibility will be determined by how you use the funds from your home equity loan or line of credit. According to the IRS, “for tax years beginning after 2017, if home equity loans or lines of credit secured by your main home or second home are used to buy, build, or substantially improve the residence, interest you pay on the borrowed funds is classified as home acquisition debt and may be deductible, subject to certain dollar limitations.”

This rule is different from what had previously been in effect. For tax years prior to 2018, the interest could be tax-deductible regardless of how the home equity funds were used, including personal matters like consolidating credit card debt. Today, the tax deduction only applies to interest on equity funds that were applied to substantial home improvements.

The deduction applies to loans up to $750,000 for combined mortgage debt, according to Investopedia. If you are married and filing your taxes separately, the cap is $375,000. If you have more than one property, it’s also crucial to note that the deduction needs to apply to the property in which the equity comes from. This means you can’t apply the deduction to your primary residence if the improvements you made were to your vacation home.

It’s also important to know that this tax advantage applies to both home equity loans and HELOCs, as opposed to just one of the products. It’s the way in which you use the funds determines your eligibility for this tax advantage.

What Home Improvements Qualify for a Tax Deduction?

The IRS states that the improvements to qualify for a tax deduction need to “buy, build, or substantially improve the residence.” Home renovations and improvements that could qualify for this deduction would include:

• A kitchen remodel
• Putting a new roof on your home
• Structural upgrades, like expanding rooms, finishing a basement or loft, or putting in energy-efficiency improvements, like thicker walls or high-efficiency windows

What Doesn't Qualify for a Tax Deduction with Home Equity Funds?

While home equity funds can be used in a variety of ways, you are limited in how you can receive a tax deduction. The following wouldn't qualify for a tax deduction when it comes to a home equity loan or line of credit:

• Debt consolidation, including consolidating credit card debt
• Vacations
• Paying for school tuition
• Starting a business

Additionally, only significant home renovations and improvements can qualify you for a tax deduction. Projects like replacing a singular appliance, painting a room, or routine maintenance or repairs wouldn't qualify.

Applying for a Tax Deduction with Home Equity Funds

There’s some crucial paperwork you’ll need if you plan to take advantage of the tax deduction on the interest from your home equity funds. You’ll want to keep a paper trail of all documents relating to your home improvement projects, including:

• Receipts
• Invoices from contractors or vendors
• Any other documents that are tied to your spending on the project

Additionally, it's important to consider working with a tax advisor. They would be an expert when it comes to filing and would know the exact documents you should have regarding this tax benefit.

Home Equity Products & American Heritage Credit Union

If you’re interested in making the most of your home and tapping into its equity, we offer both home equity loans and lines of credit products that are tailored to fit your unique needs. Our home equity loans come with low rates and terms up to 20 years. You’ll enjoy a consistent and manageable monthly payment while realizing your goals.

If you’re seeking additional flexibility and the opportunity to draw funds multiple times, our Platinum Fixed-Rate Home Equity Line of Credit may be the best option for you. This product is unique in that it comes with a fixed interest rate (as opposed to a variable rate), offering peace of mind throughout your draw period through consistent monthly payments.

Both our home equity loans and lines of credit allow you to borrow up to 95% of your home’s value, allowing you to feel rewarded for your hard work as a homeowner.