Is interest on a HELOC tax deductible?

16 Replies

Hello BP,

If I take a HELOC on my personal residence, can the interest on this loan be tax deducted? The funds from the HELOC will be used to purchase additional investment properties.

Thanks

Interest on a HELOC is subject to interest tracing rules. So if you use 50% of the proceeds of the HELOC to buy a rental property and 50% to go on vacation, then the interest becomes 50% deductible (on the target property's Schedule E) and 50% non deductible.

I believe that HELOC credit on a line up to $100k used for unrelated expenses is deductible on schedule A

It's also worth noting that I think this is an add back for computing AMT tax 

Yes, sorry - tried to give a quick answer and should not have - it lead to an incomplete answer.

The long answer is (as usual) It Depends....

This is the order of operations I usually use.

1.  Interest Tracing.  If any portion considered personal, then apply the following:

2. Apply the Debt Limit (smaller of $100,000 or the FMV less the acquisition debt.

3.  Portion of home that does not qualify

*****

Home Equity Debt

If you took out a loan for reasons other than to buy, build, or substantially improve your home, it may qualify as home equity debt. In addition, debt you incurred to buy, build, or substantially improve your home, to the extent it is more than the home acquisition debt limit (discussed earlier), may qualify as home equity debt.

Home equity debt is a mortgage you took out after October 13, 1987, that:

  • Does not qualify as home acquisition debt or as grandfathered debt, and
  • Is secured by your qualified home.

Example.

You bought your home for cash 10 years ago. You did not have a mortgage on your home until last year, when you took out a $50,000 loan, secured by your home, to pay for your daughter's college tuition and your father's medical bills. This loan is home equity debt.

Home equity debt limit. There is a limit on the amount of debt that can be treated as home equity debt. The total home equity debt on your main home and second home is limited to the smaller of:

  • $100,000 ($50,000 if married filing separately), or
  • The total of each home's fair market value (FMV) reduced (but not below zero) by the amount of its home acquisition debt and grandfathered debt. Determine the FMV and the outstanding home acquisition and grandfathered debt for each home on the date that the last debt was secured by the home.

Example.

You own one home that you bought in 2002. Its FMV now is $110,000, and the current balance on your original mortgage (home acquisition debt) is $95,000. Bank M offers you a home mortgage loan of 125% of the FMV of the home less any outstanding mortgages or other liens. To consolidate some of your other debts, you take out a $42,500 home mortgage loan [(125% × $110,000) − $95,000] with Bank M.

Your home equity debt is limited to $15,000. This is the smaller of:

  • $100,000, the maximum limit, or
  • $15,000, the amount that the FMV of $110,000 exceeds the amount of home acquisition debt of $95,000.

Debt higher than limit. Interest on amounts over the home equity debt limit (such as the interest on $27,500 [$42,500 − $15,000] in the preceding example) generally is treated as personal interest and is not deductible. But if the proceeds of the loan were used for investment, business, or other deductible purposes, the interest may be deductible. If it is, see the Table 1 Instructions for line 13 for an explanation of how to allocate the excess interest.

Part of home not a qualified home. To figure the limit on your home equity debt, you must divide the FMV of your home between the part that is a qualified home and any part that is not a qualified home. See Divided use of your home under Qualified Home in Part I.

Fair market value (FMV). This is the price at which the home would change hands between you and a buyer, neither having to sell or buy, and both having reasonable knowledge of all relevant facts. Sales of similar homes in your area, on about the same date your last debt was secured by the home, may be helpful in figuring the FMV.

The latest answer to this question is a year old, and a new law is in effect.

If I'm understanding it correctly, the Tax Cuts and Jobs Act of 2017, enacted 12/22/17, states that interest paid on any home equity loan, home equity line of credit (HELOC), or second mortgage can be deducted only if it is "used to buy, build or substantially improve the taxpayer's home that secures the loan."

https://www.irs.gov/newsroom/interest-on-home-equi...

To me, that makes it clear that interest cannot be deducted when using a HELOC or home equity loan to purchase an investment property, as that is not the home that secures (is the collateral for) the loan.

Perhaps one of the tax experts here could chime in with the latest ground truth. Thanks!

Originally posted by @Matt Powell :

The latest answer to this question is a year old, and a new law is in effect.

If I'm understanding it correctly, the Tax Cuts and Jobs Act of 2017, enacted 12/22/17, states that interest paid on any home equity loan, home equity line of credit (HELOC), or second mortgage can be deducted only if it is "used to buy, build or substantially improve the taxpayer's home that secures the loan."

https://www.irs.gov/newsroom/interest-on-home-equi...

To me, that makes it clear that interest cannot be deducted when using a HELOC or home equity loan to purchase an investment property, as that is not the home that secures (is the collateral for) the loan.

Perhaps one of the tax experts here could chime in with the latest ground truth. Thanks!

Hey Matt- That's not correct. It is deductible for business/investment purposes. 

It's no longer deductible for personal use.

However the laws regarding interest tracing HAVE NOT changed. The IRS lets you trace back interest to it's actual USE. 

This means that if the HELOC is taken out but the actual loan proceeds are used to purchase an investment, invest in business, ect...it's still deductible as a business deduction.

If possible you DO NOT want the proceeds from the HELOC to ever touch your personal account, you want it to go right to the LLC bank account for your properties.

Hi Natalie - thanks for the clarification. Personally, I'm exploring my first investment purchase, and had not planned to establish a business just to purchase this one property. So my answer was out of the context of a business.

Would you agree that someone without a business - using a HELOC to purchase an investment property, titled directly to the person - would not be able to deduct the interest?

No I wouldn't agree- that's still incorrect haha 

An investment property/business investment is the same in this context. It's just any thing NOT personal use.

You can own a rental. In your name. Take a HELOC on your house. As long as the proceeds go into a separate bank account and is only used for the purchase/improvement debt against the property it's deductible as an expense related to that investment.

Originally posted by @Natalie Kolodij :
Originally posted by @Matt Powell:

The latest answer to this question is a year old, and a new law is in effect.

If I'm understanding it correctly, the Tax Cuts and Jobs Act of 2017, enacted 12/22/17, states that interest paid on any home equity loan, home equity line of credit (HELOC), or second mortgage can be deducted only if it is "used to buy, build or substantially improve the taxpayer's home that secures the loan."

https://www.irs.gov/newsroom/interest-on-home-equi...

To me, that makes it clear that interest cannot be deducted when using a HELOC or home equity loan to purchase an investment property, as that is not the home that secures (is the collateral for) the loan.

Perhaps one of the tax experts here could chime in with the latest ground truth. Thanks!

Hey Matt- That's not correct. It is deductible for business/investment purposes. 

It's no longer deductible for personal use.

However the laws regarding interest tracing HAVE NOT changed. The IRS lets you trace back interest to it's actual USE. 

This means that if the HELOC is taken out but the actual loan proceeds are used to purchase an investment, invest in business, ect...it's still deductible as a business deduction.

If possible you DO NOT want the proceeds from the HELOC to ever touch your personal account, you want it to go right to the LLC bank account for your properties.

Wait a minute. But if I don't have an LLC and want to use HELOC, taken out on my primary residence and use it as down payment on rental property to be perchased with conventional loan on my personal name, can I still deduct the interest on that HELOC?

Boy that was a long sentence

Originally posted by @Lana Lee :
Originally posted by @Natalie Kolodij:
Originally posted by @Matt Powell:

The latest answer to this question is a year old, and a new law is in effect.

If I'm understanding it correctly, the Tax Cuts and Jobs Act of 2017, enacted 12/22/17, states that interest paid on any home equity loan, home equity line of credit (HELOC), or second mortgage can be deducted only if it is "used to buy, build or substantially improve the taxpayer's home that secures the loan."

https://www.irs.gov/newsroom/interest-on-home-equi...

To me, that makes it clear that interest cannot be deducted when using a HELOC or home equity loan to purchase an investment property, as that is not the home that secures (is the collateral for) the loan.

Perhaps one of the tax experts here could chime in with the latest ground truth. Thanks!

Hey Matt- That's not correct. It is deductible for business/investment purposes. 

It's no longer deductible for personal use.

However the laws regarding interest tracing HAVE NOT changed. The IRS lets you trace back interest to it's actual USE. 

This means that if the HELOC is taken out but the actual loan proceeds are used to purchase an investment, invest in business, ect...it's still deductible as a business deduction.

If possible you DO NOT want the proceeds from the HELOC to ever touch your personal account, you want it to go right to the LLC bank account for your properties.

Wait a minute. But if I don't have an LLC and want to use HELOC, taken out on my primary residence and use it as down payment on rental property to be perchased with conventional loan on my personal name, can I still deduct the interest on that HELOC?

Boy that was a long sentence

YES! Cool right?

The IRS allows you to trace interest. Meaning if you can prove it was used for an investment or business purpose you can deduct it against that purpose.

You should have a separate bank account for your rentals- and a best practice is to ensure the HELCO funds to DIRECTLY to that account for the property purchase and does not touch your personal bank account.

@Matt Powell and @Lana Lee

Yes, @Natalie Kolodij is absolutely correct. 

Just to clarify - the new tax reform rules apply to HELOC interest as a personal deduction on Schedule A. When buying an investment property, the HELOC interest is deducted as a business deduction on Schedule E (or C).

@Natalie Kolodij So one can write off Heloc interest paid/accrued from purchase/improvement of a rental property. Is that true for flips as well? Can I take out a Heloc on a rental property to fund purchase/improvement of a flip and write that off or only Heloc interest from purchase/improvement of a rental is a write off? Thanks! 

@Brian G. 

Valid for flips too. 

Does not matter where the HELOC is originated- just needs to be traceable to a business transaction

Your CPA should understand IRS interest tracing rules and then there shouldn't be any issues.