It is possible to use home equity loans and lines of credit to make improvements such as adding a new roof, consolidating debt or completely remodeling a kitchen or bathroom. The difference between the amount owed on an existing mortgage and a home’s market value is deemed available equity and serves as collateral for home equity loans. Many homeowners prefer these types of loans along with other debt because the interest is generally tax-deductible, with particular restrictions defined by the Internal Revenue Service (IRS).
How to Obtain a House Equity Loan and Receive Tax Benefits
Decide whether to acquire a home equity loan or home equity credit line (HELOC). Home equity loans are received as a lump sum and repaid in installments over time, typically at a fixed rate of interest and payment, according to MSN Money. Lines of credit borrowed against home equity operate like credit cards: they have variable rates of interest and cash is used and reimbursed to a maximum sum. Both loans are recorded as exemptions from the home and foreclosure is a risk in the event the homeowner falls behind on payments.
Use the proceeds from your home equity loan to your chosen purpose and keep an eye on the total sum borrowed and the interest paid. IRS rules limit the maximum amount of deductible home equity debt to $100,000 as of 2010. Main amounts exceeding $100,000 do not be eligible for interest deductions.
Determine whether you will itemize your tax deductions or take the standard deduction established by the IRS. Deductions for home equity loan interest are applied only to an itemized tax return. If you do plan to itemize, make sure your loan is secured by your qualified home and does not qualify as acquisition debt, or even a loan used to purchase, build or substantially improve a home, according to IRS guidelines. Also, make sure that the home equity loan and the home acquisition debt together do not exceed the fair market value of the home. If that’s the case, you may not be able to deduct all of the interest on the home equity loan or credit line.
Complete the worksheets and follow the directions attached to Schedule A for Form 1040 to ascertain the total amount of deductible interest resulting from your home equity loan. To calculate the total amount of interest paid for the year, consult the statements received from your lender and reconcile that amount with the figure supplied by the lending company on Form 1098 at the close of the year.