Home loans are tax deductible depending on how you use them

Last year’s lockdowns forced people to spend a lot more time at home, which has inspired many home improvement projects. To finance these renovations, additions, or repairs, many homeowners have taken out home loans.

Now that it’s time for taxation, you may be wondering: is the interest on these home loans tax deductible? The short answer is yes – but it depends on several factors and only taxpayers who break down can benefit.

A home loan allows you to borrow against the value of your home by using the equity that you have accumulated as collateral. According to ATTOM Data Solutions, a source for real estate data solutions, more than 30% of American homeowners are considered “equity rich,” which means that the total amount of their home loans is 50% or less of the estimated value of their home.

Don’t confuse a home equity loan with a home equity line of credit or HELOC. A home equity loan offers homeowners a lump sum, while a HELOC offers a predetermined amount that you can access here and there to cover the expenses.

When you’re ready to pay your taxes, here are a few things to know about applying for home loan interest tax deduction.

Is the interest on my home loan tax deductible?

Whether or not the interest on your home loan is tax deductible depends on two factors: whether you have spent the money making significant improvements to a qualified home – your primary or secondary home – and the total amount of your mortgage debt.

“If you’re using it to expand your kitchen, add a patio, or upgrade your home, then it’s tax deductible,” said Thomas Castelli, CPA and partner at The Real Estate CPA in Raleigh, North Carolina. “Let’s say you take out a home equity loan on this primary residence and use it to go to Turks and Caicos Islands. It’s not deductible. ”

For any mortgage taken out after December 16, 2017, you can only deduct interest on loans – including a combination of a main mortgage and home equity loan – up to $ 750,000. The limit is $ 1 million on mortgages taken out before that date.

If your home debt burden exceeds those amounts, you could only deduct part of the interest, Castelli explains. In these cases, it’s a good idea to speak to an accountant to find out what your interest deduction would be.

How to apply for an interest deduction on a home loan

If you want to claim the interest deduction on your home loan, you will need to itemize your deductions. A separate deduction is an expense that reduces your adjusted gross income and lowers your overall tax bill.

However, the majority of taxpayers take the standard deduction instead. The standard deduction is $ 24,800 for a married couple and $ 12,400 for an individual, according to the IRS. Since the standard deduction was raised under the Tax Cuts and Jobs Act of 2017, the number of individual taxpayers has decreased by 17 percentage points, according to the tax foundation.

To be eligible for home loan interest deductions, your total individual deductions – including mortgage interest and charitable donations, state and local taxes, and other qualifying expenses – must be greater than the standard deduction.

“A lot of people think, ‘I have a mortgage and I can use the interest as a deduction on my tax return.’ But you have to exceed that standard deduction to do this, ”said Karl Schwartz, CPA, Certified Financial Planner and Principal and Senior Financial Advisor at Team Hewins, a financial planning and investment firm. “If you don’t have a lot of other prints, you may not be able to use any of them [the home equity loan interest]. ”

What home loan interest rates are tax deductible?

All interest on your home loan is deductible as long as your total mortgage debt is $ 750,000 (or $ 1 million) or less, you list your deductions, and the IRS says the loan is to “buy, build, or improve” your home.

The IRS has not defined what exactly that entails. “Basically, it’s about making capital improvements to your main or second home,” says Castelli. “Anything that improves the value of your home is largely considered a capital improvement.”

For example, if you were to spend the money replacing a roof or siding, adding a room, remodeling the kitchen, or even installing a pool, the interest on your home loan would likely be deductible.

Any home improvement project that is paid for with your home loan must be done on the house that secures the loan.

Home Loan Tax Withholding Rules

To be eligible for a tax deduction, you must be able to provide evidence of how you spent your home loan. So keep any invoices, receipts, bank statements, or other record that shows payments to contractors or materials purchased.

“As long as you can attribute the funds to a specific qualifying purchase, which would be an improvement over qualifying residency, you can deduct the interest,” said Nathan Rigney, JD, senior tax analyst at The Tax Institute at H&R Block.

Which forms do you need for this interest deduction?

Your lender should send you a Form 1098, Mortgage Interest Statement, by the end of January each year.

“It tells you how much interest you’ve paid over the year, and then there’s other information too, like the credit balance,” explains Schwartz.

Only interest of $ 600 or more will be reported on this form. If your interest is below that, you may not get a 1098, but you can still include the interest on your tax return.

Pro tip

Only taxpayers who break down their deductions can claim the interest deduction on their home loan. Interest, along with other deductions, would need to be more than $ 12,400 for a single person.

The bottom line

A home equity loan is a great way to pay for repairs and upgrades that create a much more pleasant living space and even add to the value of your home. However, several factors affect whether or not you can deduct the interest on the loan. It depends on how you are spending the money, how much debt you owe on your home, and how many other tax deductions you have.