After the Tax Cuts and Jobs Act (TCJA) became law in 2017 homeowners find it more complicated to obtain a deduction when they borrow against their home’s equity—but it’s still possible if you meet certain criteria.
You can borrow against your home’s equity in two main ways. You can take out either a home equity loan or a home equity line of credit (HELOC). Both allow you to borrow against the equity that you have in your home.
You will need to decide which one of the two best suits your situation and how much money you will need over a certain period. Both a home equity loan and a HELOC carry the same risk of foreclosure if you are in danger of going underwater or if your home’s value goes down significantly.
Rules You must meet certain criteria to qualify for a tax deduction for your home equity loan or a HELOC.
Only the interest on the home equity loan or the HELOC may be deducted, and it must be used to buy, build, or significantly improve the home that secures the loan.
The Internal Revenue Service doesn’t clearly state what does and doesn’t count under buy, build, or significantly improve. If you’re unsure if your expenses will count, save your receipts, and arrange a meeting with an accountant.
Leveraging your home’s equity just for the sake of lowering your taxes may not be the best decision. The high standard deduction means that you may not have tax savings.
The TCJA substantially raised the standard deduction in 2022 to $12,950 for single filers and married couples filing separately or $25,900 for married couples filing jointly, rising to $13,850 for single filers and $27,700 for couples in 2023.
Taking the standard deduction may result in the highest refund. For those already itemizing for other reasons, adding on home equity tax deductions can reduce their tax bill.
A home equity line of credit (HELOC) and a home equity loan both use the equity that you have in your home as collateral. A HELOC is a credit line that allows you to spend, or not spend, up to your limit as needed and pay down over time. A home equity loan is a loan for a set lump sum that you make fixed interest rate payments on over a specified period.
Individual requirements vary among lenders, but you’ll need a minimum of 75% equity in your home for a HELOC. Most lenders require a minimum of 80% equity for a home equity loan.
To calculate the percentage of equity that you have in your home, subtract the current balance on any loans that you have on your home from the current estimated value of your home. Next, divide that figure by the value of your home.
Here’s how that works with a home valued at $400,000 with a loan balance of $300,000.
$400,000 – $300,000 = $100,000
$100,000 ÷ $400,000 = 25%
In other words, this homeowner has 25% equity.
No matter how much money you’re using to invest elsewhere now that the new tax laws have changed, it’s still possible to take advantage of a home equity loan deduction. The increased standard deduction might cause it to be less likely that you’ll qualify for this perk, but if you opt for itemizing deductions, you may still be able to claim this benefit.
If you have a preferred agent to work with, let us know and we will forward your information to them. If not, we will happily introduce you to one of our qualified agents to assist you in the buying or selling process.
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