If you use a home equity line of credit for personal use, do you know you may be in trouble with the IRS if you plan to claim a deduction for mortgage interest?
Are you not entirely certain how you could end up paying penalties to the IRS.
Do not worry you are not alone. You see we all believe that the interest you pay for your home (mortgage and a HELOC interest) is tax deductible. I found out the hard way that this is not really the case.
When you refinance on your home and use the money for any reason other than home improvement, the IRS limits your deduction for interest. In some cases you won't be able to claim the deduction at all.
Well, the way this is set up, the IRS in general does allow you to deduct interest on your HELOC for tax purposes. They call this the home equity indebtedness deduction.
The home equity indebtedness means:
The IRS generally gives you a deduction based as follows: You are allowed to claim mortgage interest deduction up to $100,000 if you file a joint return or up to $50,000 if you file a separate return. This relates to refinancing or borrowing extra from your mortgage.
Now that you understand the deduction here's how they take it away from you.
The example below explains this in more detail
Let us assume at the time when you first acquired your home you paid $300,000. But now you only owe a balance of $260,000.
YOU took $30,000 from your HELOC and decided to use this for personal use. And you figured that since you borrowed the money from the HELOC the interest paid on the $30,000 is fully tax deductible. You also received some good news the day you borrowed this extra money. You were told that your home is valued at $320,000.
You may be in for a surprise. If you previously claimed a deduction or thought of claiming a deduction this year, the IRS may limit your interest deduction lowering your refund.
Here is how the IRS limits your deduction. Take the current value of your home and deduct the cost. So $320,000 less $300,000 is $20,000. So what this means is that you can only claim the interest payments up to $20,000 and not $30,000 resulting in a smaller refund. This only applies if you borrowed extra money and used this for personal use.
Now if the market value of your home has decreased below the cost of your home, you cannot claim interest on any of the $30,000 you borrowed. I have seen hundreds of clients caught up in this potential tax trap and most of them have their taxes completed by their tax accountants. So if you home is worth $290,000 today and the original cost is $300,000, the entire interest you paid on the $30,000 you borrowed cannot be claimed for tax purposes.
A quick test to see if you are able to claim the deduction for mortgage interest.
Please click on the links below and quickly access a list of points or a special check list. In this list, we have provided the steps preventing you from making a silly mistake when preparing your tax return.
If you are filling out your tax returns this year, and you have used funds from your HELOC for personal use, I strongly suggest that you first contact your tax accountant to figure out whether the interest is tax deductible. This is the best move right now, and could prevent you from paying extra taxes and penalties later on.
Please note that this article is for informational purposes only. No liability is assumed with the information presented above. - 16035
Are you not entirely certain how you could end up paying penalties to the IRS.
Do not worry you are not alone. You see we all believe that the interest you pay for your home (mortgage and a HELOC interest) is tax deductible. I found out the hard way that this is not really the case.
When you refinance on your home and use the money for any reason other than home improvement, the IRS limits your deduction for interest. In some cases you won't be able to claim the deduction at all.
Well, the way this is set up, the IRS in general does allow you to deduct interest on your HELOC for tax purposes. They call this the home equity indebtedness deduction.
The home equity indebtedness means:
The IRS generally gives you a deduction based as follows: You are allowed to claim mortgage interest deduction up to $100,000 if you file a joint return or up to $50,000 if you file a separate return. This relates to refinancing or borrowing extra from your mortgage.
Now that you understand the deduction here's how they take it away from you.
The example below explains this in more detail
Let us assume at the time when you first acquired your home you paid $300,000. But now you only owe a balance of $260,000.
YOU took $30,000 from your HELOC and decided to use this for personal use. And you figured that since you borrowed the money from the HELOC the interest paid on the $30,000 is fully tax deductible. You also received some good news the day you borrowed this extra money. You were told that your home is valued at $320,000.
You may be in for a surprise. If you previously claimed a deduction or thought of claiming a deduction this year, the IRS may limit your interest deduction lowering your refund.
Here is how the IRS limits your deduction. Take the current value of your home and deduct the cost. So $320,000 less $300,000 is $20,000. So what this means is that you can only claim the interest payments up to $20,000 and not $30,000 resulting in a smaller refund. This only applies if you borrowed extra money and used this for personal use.
Now if the market value of your home has decreased below the cost of your home, you cannot claim interest on any of the $30,000 you borrowed. I have seen hundreds of clients caught up in this potential tax trap and most of them have their taxes completed by their tax accountants. So if you home is worth $290,000 today and the original cost is $300,000, the entire interest you paid on the $30,000 you borrowed cannot be claimed for tax purposes.
A quick test to see if you are able to claim the deduction for mortgage interest.
Please click on the links below and quickly access a list of points or a special check list. In this list, we have provided the steps preventing you from making a silly mistake when preparing your tax return.
If you are filling out your tax returns this year, and you have used funds from your HELOC for personal use, I strongly suggest that you first contact your tax accountant to figure out whether the interest is tax deductible. This is the best move right now, and could prevent you from paying extra taxes and penalties later on.
Please note that this article is for informational purposes only. No liability is assumed with the information presented above. - 16035
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If you have refinanced and used the proceeds for personal and looking for tax forms I encourage you to download the free tax deductions checklist for the above topic.
