One nice feature of home equity loans is that borrowers may get a tax deduction on interest paid for the loan. Before you try this, you should understand that the tax deduction is not unlimited. This page explains how the tax deduction really works.
Deducting Mortgage Interest
Taxpayers can claim a deduction on interest paid on a loan secured by their first or second home. Most home equity loans fall into this category, but borrowers can get confused if they have multiple “second” homes or mortgages in excess of a home’s value. For details on how a home might qualify, see IRS Publication 936 Section 1.
Advantages of Deducting Mortgage Interest
This goes without saying, but the advantage is that you save money. For example, you may use a home equity loan as part of a debt consolidation program. Suddenly, the interest you pay becomes tax deductible – not just an expense. Of course, you still have to make the debt go away. If you run the numbers this can work out in your favor.
The interest deduction from your home equity loan is not unlimited. You can generally deduct interest you pay on the first $100,000 of a home equity loan. After that, it depends. If the home equity loan was used to improve your first or second home – or to purchase a second home – you can probably take the deduction on an amount up to $1 million or the value of the home. IRS Publication 936 Section 2 contains more detail.
As far as the alternative minimum tax (AMT) goes, your home equity loan deductions will only help you if you used the money for home improvements.
Where to go For More Information
Tax laws are complex and they change often. If you’re thinking about taking a mortgage interest deduction, make sure it’s legal. The IRS Website irs.gov is really pretty helpful. In addition, it’s probably worth the modest expense of visiting with a good local tax advisor just to make sure. Our Taxes guide at www.taxes.about.com is also pretty good at explaining things in plain English.
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