A Quick Education on the Tax Implications on Home Equity Loans

Many people mistakenly believe that they will be able to deduct dollar for dollar the amount of interest they pay on their home equity loan. Instead once you delve into the tax implications on home equity loans, you will understand whether or not you will be able to deduct this interest.

First, the Internal Revenue Services (IRS) distinguishes between home equity debt and acquisition debt, and this is one of the tax implications on home equity loans that many people do not know. Acquisition debt is used to add to or improve your home. Acquisition debt is used to remodel rooms, add rooms, put down a driveway, and make other improvements. The interest on the first million dollars you’ve borrowed in acquisition debt is completely tax deductible.

If you’ve borrowed on a home equity loan, though, your interest is only tax deductible on the first $100,000 you ever borrow. Home equity is the difference between the value of your home and the amount you still owe. You may borrow this money for tuition payments, debt consolidation, or other major expenses. If you borrow more than $100,000, however, you cannot deduct the interest you paid on any amount over the $100,000 mark.

If you’ve borrowed a much smaller amount, you may not be able to deduct the second mortgage interest anyway. The standard deduction for a married couple is $7,200. If you paid less than that amount in interest on your home equity loan with all other deductible items combined, you will use the standard deduction instead of the itemized deduction. In this case, you will not be able to deduct the interest specifically.

Another possible stumbling block in deducting your interest is if you have in fact borrowed an amount greater than the difference between market value and the remaining mortgage. If, for example, the market value of your home is $300,000, and you still owe $250,000, you cannot deduct interest on the loan amount over $50,000.

Of course, you actually have to be paying the debt to have the deductions. If you’re replacing credit card debt, you’re benefiting by the tax deduction. You have the debt anyway, and you cannot deduct the interest you pay annually on your revolving debt. If you are using the debt to pay off medical bills or to pay for tuition, however, you are paying money on a debt you wouldn’t have otherwise. In that case, while you may be able to deduct a certain amount, without the home equity loan, the money you paid in interest would stay in your pocket.

It is important to understand fully the tax ramifications for borrowing against the value of your home. Consult a tax professional before you make any decisions.