While most interest expense is no longer tax deductible, it is a viable deduction if the interest is on your primary or secondary residence. While limits apply, the use of a secondary loan on your primary or secondary residence can also qualify for interest deductibility. However, “home equity” loan interest can often lose its tax deductibility if you're not careful. Here is what you need to know.
The first thing to understand is whether the debt secured by your residence is considered "Home Acquisition Debt" or "Home Equity Debt" per the IRS.
Home Acquisition Debt: Home Acquisition Debt is debt used to purchase, or refinance a primary or secondary residence. It also includes debt used to substantially improve your property. Interest deductibility of this type of debt is limited to the fair market value of the property or a total Acquisition Debt limit of $1 million ($500,000 if married filing separately). The interest expense is deducted as an itemized deduction on Schedule A of your 1040.
Home Equity Debt: Home Equity Debt is all other debt secured by your primary or secondary residence. Interest deductibility of this type of debt is limited to the fair market value of the property taken in conjunction with Home Acquisition Debt. In addition, home equity interest deductibility is limited to Home Equity Debt of $100,000 ($50,000 if married filing separate).
Because interest on home equity loans can be tax deductible as an itemized deduction, many see this as the preferred method of borrowing. Common uses of home equity:
If you are counting on using your Home Equity Loan interest as a tax deduction you will want to make sure you understand the pitfalls. All too often home equity loans and their related interest become a problem when:
While Home Equity Debt can provide a valuable tax deduction, you must stay vigilant to the rules and understand your situation. Remember a default on a credit card doesn't necessarily risk losing your home, a default on your home equity loan could put you on the street.