Homeowners increase their level of home equity with each monthly mortgage payment. Equity is also increased as the value of a property rises over time. Homeowners may be able to take a tax deduction for the cost of interest on a home equity loan, even if the loan proceeds are used for personal expenditures.
Two different uses of equity
The deductibility of a home equity loan depends largely on how the proceeds from the loan are used. All mortgage loans secured by the property must be categorized as one of two types. Any loan used to buy, build, or improve the property itself is categorized by the IRS as acquisition debt. All secured loans used for unrelated purposes are referred to by the IRS as home equity debt.
Limitations based on loan use
Acquisition debt and equity debt have different limits on deductibility. You may deduct the interest paid on up to $1 million in acquisition debt. To deduct interest on a home equity loan used for personal uses, the fair market value of your home must exceed the acquisition debt. The amount of a home equity loan on which interest is deductible is limited to the lesser of the following:
- The difference between acquisition debt and current value of the home
If you have no current mortgage on your home, you may obtain a home equity loan for up to $100,000, for any purpose, and deduct the interest. A home equity loan is a practical method to finance an automobile or any other type of asset, since interest on personal items is usually not deductible.
Second home inclusion
Tax filers are allowed to deduct interest on two homes. The deduction limitations are not increased by the inclusion of a second home. Whether you have one home or two separate houses, the limitations remain $1 million for acquisition debt and $100,000 for equity debt. For married persons filing separately, the limits are $500,000 for acquisition debt and $50,000 for equity debt.
Other home types
In addition to a traditional house, qualifying home structures include condominiums, mobile homes, and boats with living facilities. For all home structures, acquisition debt includes loans secured by the structure for its initial purchase or construction, as well as subsequent loans used for improvements.
Home mortgage interest is often the largest itemized deduction for tax filers who itemize. The inclusion of a deductible home equity loan creates an additional tax benefit. Contact a specialist in home loans like one from Union State Bank for more information about the advantages of a deductible home equity loan.