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Home equity loans can be used for any number of reasons. Whether you want to consolidate or pay down high-interest credit card debt, finance a major home repair or project or pay for big expenses like a wedding or college education, a home equity loan can provide the means to do so. And, in today’s elevated rate climate, home equity loans come with interest rates that are much lower than what’s often available with credit cards, personal loans and some other borrowing products.
But those aren’t the only advantages of accessing your home equity now. With the average amount of equity sitting around $320,000, many homeowners have a six-figure sum of money at their disposal currently. And they can use that large amount to purchase a second home. This may lead some borrowers to wonder, then, about the potential for a tax deduction. Home equity loan interest, in some instances, may qualify to be deducted from your taxes for the year in which it was used. But can you deduct interest on a home equity loan if you use it to buy a second home? That’s what we’ll cover below.
See how much home equity you’d be eligible to borrow here now.
Can you deduct interest on a home equity loan if you use it to buy a second home?
While many homeowners may benefit from using their home equity loan funds to purchase a second home for rental or vacation purposes, they should go into the process clear-eyed and knowledgeable. Putting your initial home up as collateral to secure the loan should only be done if you can easily afford to make three payments — your initial mortgage loan, the home equity loan and the new mortgage payment. But homeowners should be aware that, when used in these circumstances, interest on the home equity loan won’t qualify for a tax deduction.
“Interest on home equity loans and lines of credit are deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan,” the IRS says. “The loan must be secured by the taxpayer’s main home or second home (qualified residence), and meet other requirements.
“Generally, you can deduct the home mortgage interest and points reported to you on Form 1098 on Schedule A (Form 1040), line 8a,” the IRS continues to explain online. “However, any interest showing in box 1 of Form 1098 from a home equity loan, or a line of credit or credit card loan secured by the property, is not deductible if the proceeds were not used to buy, build, or substantially improve a qualified home.”
In other words, if you borrow from your first home and use the funds to make repairs to it, you’ll generally qualify for the tax deduction. But if you use the funds to purchase another home or property, you won’t. Still, that doesn’t mean that a home equity loan isn’t the right way to finance a second home purchase. In many instances, it still is. But a tax deduction won’t come into consideration in these unique circumstances.
Learn more about your home equity loan options here.
Which projects qualify for home equity loan tax deductions?
So, what projects do qualify for home equity loan tax deductions? While you should speak to a tax professional or accountant before getting started, typically, homeowners can expect the deduction to apply for home projects like:
- Solar panel installations
- Roof replacements
- New bathrooms or bedrooms
- Kitchen renovations
- Bathroom renovations
This is not an exhaustive list, however, so be sure to confirm your tax deduction eligibility before getting started with any of the above projects.
The bottom line
Homeowners won’t be able to deduct the interest on their home equity loan if they use it to buy a second home but if they use it to make IRS-eligible projects and repairs, they will qualify. This makes home equity loans, with their low interest rates, greater borrowing potential and flexible repayment terms, even more attractive, especially in today’s interest rate climate. So, if you know you need a large sum of money right now, a home equity loan may be one of your better options.
Learn more about borrowing with a home equity loan online.