July 11, 2023
What are all of the ways a HELOC may be tax deductible?
If you need to make renovations and have equity in your home, a Home Equity Line of Credit (HELOC) might be a great solution. However, not all expenses purchased with HELOC funds are tax deductible. To maximize the funds from your HELOC, consider these conditions and qualifications before getting started and consult a tax adviser for further information regarding the deductibility of interest and charges.
How does a HELOC work?
With a HELOC, you can use as little or as much money as you need and only pay back what you use. The funds work a lot like a credit card; however, your borrowing limit is based on the amount of equity you have in your home or the amount you have already paid off.
Unlike a credit card, HELOCs have a set draw and repayment period. This means you can only take money out during the draw period where you will then only be required to make interest payments on the loan. At the end of the draw period, you must begin repayment on the full loan amount including the new principal and interest.
Keep in mind, a HELOC is also a variable-rate loan with fluctuating interest payments that may impact your monthly payments. Before opting for a HELOC it is important to understand the pros and cons, or you may end up taking on more debt than you planned.
Despite its many guidelines, a HELOC can be a smart financial decision when undergoing substantial and costly renovations as they usually have lower interest rates than a personal loan or credit card.
What are the types of projects that qualify for tax deduction?
In 2017, the laws for HELOC tax deductions changed and qualification became dependent on how you plan to spend the funds. According to the IRS (Internal Revenue Service), the interest you pay on your HELOC might be tax deductible, but only if the funds are used to “buy, build, or substantially improve” your home. This means a HELOC is not tax deductible if you use the funds to pay for personal items like the purchase of a new car or debt consolidation.
The rules are clear; transactions are only tax deductible if you plan to undergo major renovations on the home. An example of this would be, if you took out a HELOC for $20,000 and only used $15,000 for home upgrades and used the other $5,000 to consolidate debt, you would only be able to deduct the $15,000 you used for the home upgrades.
Lastly, renovations only qualify for tax deductions when made on the property in which you are taking out the loan. You are not qualified to use the funds to renovate a second home, rental, or vacation property.
Which home improvement projects qualify for tax deductions?
Keep in mind, qualifiable home improvement projects are described as “permanent alterations made to a home that increase its value,” repairs do not count. Make sure you understand the difference between an improvement and a repair before using any funds. Here is a list of common home improvements that qualify for tax deductions.
- Replacing an HVAC system
- Energy-efficient improvements
- Resurfacing your driveway
- A new roof
- Decks and porches
- Home improvements for medical purposes
- Installing insulation
- New windows
- Plumbing and electrical
- Swimming pool
- Adding a bathroom
Which documents and records are required for tax submission?
It is a good idea to keep an itemized expense report and a record of your bank statements while using HELOC funds. While it is not often the IRS conducts an audit, you still don’t want to take any chances. Maintaining records is also the only way to qualify for tax deductions which maximize your borrowing potential and add the most value to your home.
Documentation is important before beginning any home improvements or renovations. Be sure to create a digital folder and save all itemized receipts and important documents like contracts and written statements throughout the duration. You will need itemized receipts to receive any tax deductions.
Speak to a tax professional
Tax regulations can be difficult to understand and are constantly changing. Consulting with a tax professional can help maximize your savings and deter any legal recourse.
Consult with a real estate professional
Not only will a real estate professional have basic knowledge regarding tax-deductible home improvements, but they will also know which home improvements can offer the most return on investment, as well as projects trending in your neighborhood.
Still have questions?
With the help of a tax professional, you’re well on your way to maximizing the equity in your home. Just remember, there are many considerations to make before you begin, and having a plan in place will help you qualify for more tax deductions to invest right back into the value of your home.