How the Home Equity Loan Interest Tax Deduction Works

One nice feature of home equity loans is that borrowers may get a tax deduction on interest paid for the loan. However, keep in mind that this kind of deduction requires careful planning and cannot be used unlimited.
 
Deducting Mortgage Interest
Tax payers can claim a tax deduction on interest paid on a loan secured by their first or second home. Nowadays most home equity loans actually fit this category, but borrowers can get confused if they have more than one “second” homes or mortgages. For example, you may use a home equity loan as part of a debt consolidation program. Suddenly, the interest you pay becomes tax deductible – not just an expense. The interest deduction from your home equity loan is not unlimited. You can generally deduct interest you pay on the first $100,000 of a home equity loan. After that, it depends. If the home equity loan was used to improve your first or second home – or to purchase a second home as an example – you can eventually take the deduction on the amount up to $1 million or the value of the home. Please refer to IRS Publication 936 Section 2 for more details. There are some gotchas if you file your taxes and need to pay AMT. As far as the alternative minimum tax (AMT) goes, your home equity loan deductions will only help you if you used the money for home improvements. Debt consolidation using your home will not work out as expected in that case.

One important thing to keep in mind is that if you use a home equity line of credit to consolidate your debt, make sure you apply the savings towards the loan principal. After all you are dealing with your house, the place where you live. You do not want to end up losing your house due to excessive spending on your credit cards for non-essential items.

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December 25, 2007 | Filed Under Tax Advice

 

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