Is All Interest on Home Equity Loan Deductible?
A home equity loan or home equity line of credit uses your house as collateral. Knowing how the Internal Revenue Service classifies the debt and the limits on the deductions helps you determine if you can deduct all the interest on your home equity loan.
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Home Equity Debt or Mortgage Debt
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When you take out a home equity loan, the debt may be classified as either mortgage debt or home equity debt. If you use your home equity loan to improve your home, such as installing new energy-efficient windows, you count the debt as mortgage debt. If you use the home equity loan for any other purposes, such as buying a new car or taking a family trip, the loan counts as home equity debt.
Limits
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The difference between mortgage debt and home equity debt matters because mortgage debt has a much higher limit for tax deductions. For mortgage debt, you can deduct the interest on up to $1 million. For home equity debt, the limit is much lower; you can deduct the interest on up to only $100,000. For example, if you have $400,000 of mortgage debt, you could deduct all the interest, but if you have $400,000 of home equity debt, you could deduct only 25 percent of the interest.
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Married Couples Filing Separately
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If you are married and use the married filing separately income tax filing status, the IRS halves the amount that each spouse can deduct for both mortgage debt and home equity debt. With mortgage debt, each spouse can deduct the interest on up to $500,000 of mortgage debt, so the total is still up to $1 million per married couple. With home equity debt, each spouse can deduct the interest on up to $50,000.
Itemization Requirement
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To claim the interest you pay on your home equity loan, regardless of whether the debt constitutes mortgage debt or home equity debt, you must itemize your deductions. When you itemize, you relinquish the standard deduction. If you do not itemize, you cannot deduct any of the interest on home equity debt. You itemize your deductions on Schedule A and file your taxes using Form 1040.
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