HELOC and Interest Deduction

By John Hewitt

  • Overview

    HELOC and Interest Deduction
    Home-equity lines of credit (HELOC) are tax-advantaged accounts, but there are many exceptions to the amount that you are allowed to deduct. The commonly cited figure of deductions up to $100,000 misleads most borrowers, particularly those who live in homes with relatively low value who are using the money to pay for nonresidential purposes.
  • Significance

    Many homeowners turn to home-equity lines of credit as a method to consolidate debt into a lower-interest account while saving on their taxes. They can also use these lines of credit to finance home improvements, as those projects will in turn increase the value of the home. If the borrowers use the funds for residential purposes, the interest paid on the line of credit can be deducted up to an amount equivalent to the value of the home.
  • Considerations

    Many homeowners find themselves in trouble when they discover that the tax-deductible portion of the interest paid is very limited if the value of all loans secured by the home--the mortgage and other home-equity loans and lines of credit--exceed the actual value of the home. In that case, the deduction is capped at the difference between the fair market value and the equity the homeowner possesses. This often leads to deduction limits far less than $100,000.

  • Warning

    When the home-equity line of credit is used for nonresidential purposes or to purchase or maintain a property that is not a first or second home, the interest that can be deducted is capped at $100,000. Otherwise, any interest paid can be accounted for as an itemized deduction on the income tax or alternative minimum tax.
  • Prevention/Solution

    Before signing an agreement for a home-equity line of credit, ensure that you have read through all relevant documentation. Educate yourself on the Truth in Lending Act in the resources below to determine if any important information is missing from the material that you have been provided. If you are taking out a home-equity line of credit particularly for the tax deduction, consider discussing it in depth with a professional financial adviser or an accountant.
  • Expert Insight

    Home-equity lines of credit are adjustable rate accounts. Count on the interest rate increasing during the repayment period. This is particularly important for financial planning if the line of credit is being taken out in an attempt to consolidate debt, reduce tax burden or both. In many situations, it may be the case that taking out the line of credit may only increase your tax and debt burden because of the need to bring in extra income to pay a more highly adjusted interest rate. Think about other alternatives for tax deductions.
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