Home Equity Loans and the Cap on Home Loan Tax Deductions

The Tax Cuts and Jobs Act (TCJA), signed into law on Dec. 22, 2017, made significant changes to the deductibility of interest on home loans. Most important, the amount of interest that you can deduct on qualified residence loans is now limited to $750,000 for single filers and married couples filing jointly (or $375,000 if married filing separately), down from $1 million (or $500,000 for married filing separately) previously.

Key Takeaways

The Tax Cuts and Jobs Act (TCJA) lowered the dollar limit on residence loans that qualify for the home mortgage interest deduction.
The limit decreased to $750,000 from $1 million for single filers and married couples filing jointly (or $375,000 for married filing separately, down from $500,000).
A qualifying loan must be for a taxpayer’s first or second home.
In addition to mortgages, home equity loans, home equity lines of credit (HELOCs), and second mortgages qualify for the deduction if the total of all loans does not exceed the $750,000 limit.
Home equity loan and HELOC interest deductions are only allowed under the new TCJA rules if the loan is used to “buy, build or substantially improve” the home that is secured by that loan.

The Cap on Home Mortgage Tax Deductions

How much interest you can deduct on your tax return depends on the date of your loan, the amount of your loan, and how you use the loan proceeds.

Post–Tax Cuts and Jobs Act

For home loans taken out on or after Dec. 16, 2017, interest is fully deductible if your loan balances total $750,000 or less for single filers and married couples filing jointly (or $375,000 or less if married filing separately). If your home loan balances exceed this amount, the interest is only deductible up to the cap. Additionally, for a home equity loan or a HELOC, the proceeds from the loan must be used to “buy, build or substantially improve” the home securing the loan for the interest to be deductible. This law runs for taxes from 2018 until 2026.

Pre-Tax Cuts and Jobs Act

For home loans taken out before Dec. 16, 2017 but after Oct. 13, 1987, the interest is fully deductible if your loan balances total $1 million or less for single filers and married couples filing jointly (or $500,000 or less if married filing separately). If your home loan balances exceed this amount, the interest is only deductible up to the cap. However, for tax years 2018 to 2026, interest on home equity loans or HELOCs is only deductible if the loan proceeds are used to “buy, build or substantially improve” the home securing the loan, even if the loan was taken out before the law was passed.

There is an exception: If you entered into “a written binding contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018,” and if you actually closed on the residence prior to April 1, 2018, then you are “considered to have incurred the home acquisition debt prior to December 16, 2017.”

Legacy debt

If your mortgage loan was acquired on or before Oct. 13, 1987, there is no limitation on your home mortgage interest deduction. This legacy debt (the Internal Revenue Service still uses the old term “grandfathered,” despite its racist roots) is fully deductible if it was secured by your qualified home at all times after that date. Also, there are no restrictions on the use of the proceeds for legacy debt to qualify for the home loan interest deduction.

If you refinanced a loan secured by the qualified home after Oct. 13, 1987, for an amount not more than the mortgage principal left on the debt, the refinance also qualifies as legacy debt.

Qualified Residence Loans

Loans secured by your primary or secondary home (also referred to as your qualified residence) that do not exceed the relevant cap based on acquisition date may qualify for the home mortgage interest tax deduction. Types of loans that qualify include your primary mortgage, secondary mortgage, home equity loan, or HELOC.

Since the TCJA passed, home equity loans and HELOCs qualify for the home mortgage interest deduction only to the extent that the proceeds are used to “buy, build or substantially improve” upon the home secured by the loan and that the total value of all loans do not exceed the relevant cap. The interest deduction for home equity loans or HELOCs is suspended for tax years 2018 to 2026 if you use the proceeds for any other purpose.

Examples of Home Loan Tax Deductions

Here are some examples of situations where the home mortgage interest deduction is allowed vs. not allowed.

Fully deductible home equity loan

In January 2022, Sarah took out a $400,000 mortgage to purchase a primary home. In April 2022, she took out a $200,000 home equity loan to build an addition on her home. In this example, the total value of Sarah’s loans do not exceed the $750,000 cap, the use of the home equity loan qualifies for the interest deduction, and both loans are secured by the primary home. All of the interest is deductible.

Two fully deductible mortgage loans

In January 2022, Tom took out a $300,000 mortgage to purchase his primary home. In May 2022, he took out a $250,000 mortgage to purchase a vacation home. Both loans are secured by the homes purchased with the funds—the primary and vacation homes, respectively. In this example, the total value of Tom’s loans do not exceed the $750,000 cap, the loans are secured by the proper qualified residence, and all of the interest is deductible.

Not a deductible home equity loan

In January 2022, Jose took out a $300,000 mortgage to purchase his primary home, valued at $800,000. In March 2022, he took out a $250,000 home equity loan on the primary home to purchase a vacation home. In this example, the total value of the loans is less than the $750,000 cap. However, the use of the proceeds from the home equity loan does not qualify for the tax deduction. The loan is secured by the primary home and was used to purchase the vacation home. Therefore, the interest on the home equity loan is not tax deductible.

Partially deductible mortgage loan

In January 2022, Kat took out a $500,000 mortgage to purchase her primary home. In May 2022, she took out a $400,000 mortgage to purchase a vacation home. Both loans are secured by the homes purchased with the funds—the primary and vacation homes, respectively. In this example, the loans are secured by the proper qualified residence. However, the total value of the loans exceeds the $750,000 cap. Only a percentage of the total interest paid by Kat is deductible.

Is interest on a home equity loan or a home equity line of credit (HELOC) deductible as a second mortgage?

It depends. Interest on a home equity loan or a home equity line of credit (HELOC) is only deductible if the proceeds are used to “buy, build or substantially improve” upon the home that secures the loan. This means that interest cannot be deducted if you used the proceeds to pay personal living expenses.

Additionally, you cannot deduct interest on a home equity loan that you’ve taken out on your primary residence to purchase a second residence. For the deduction, the home equity loan proceeds must be used on the qualified residence that is secured by the loan.

I took out a home equity loan to pay off credit card debt. Is the interest deductible?

No, your loan interest is not deductible if used for personal debts. A home equity loan qualifies for the interest deduction only if the proceeds were used to “buy, build or substantially improve” upon the home that secures the loan.

How do I find my mortgage interest for the year?

Your mortgage lender will report the annual amount of mortgage interest that you paid on Form 1098. When you receive Form 1098, you can use this amount to record your mortgage interest deduction on Schedule A, line 8a, of Form 1040.

The Bottom Line

Some home equity loans and HELOCs are eligible for the mortgage loan interest deduction, but only if you meet the loan cap requirements and use the home equity loan or the HELOC for the permitted purposes. Review your deductions carefully to be sure that you meet the requirements.