Insurance and Credit

Have you ever refinanced your home, used the proceeds for personal use, and then claimed a tax deduction for the interest? I have some bad news. The IRS limits the amount you can claim as an interest deduction for tax purposes.

You are not sure what I am talking about

It is not your fault. You are not alone. We are told that HELOC interest is deductible for tax purposes but sometimes, especially in this economy, this may not be the case, and you could land up in serious trouble with the IRS.

Do you know when you take a cash out refinance from your home equity line of credit or decide to borrow money against your HELOC, the IRS limits the amount you can deduct for tax purposes, and in this case mortgage interest. In some cases if your home has devalued you won’t be able to claim the deduction at all.

The IRS does give you some tax benefit and call this the home equity indebtedness deduction.

The home equity indebtedness means:

One of the deductions that the IRS gives you as a homeowner is to claim a mortgage interest deduction of up to $100,000 if you file a joint return. If you file a single or separate return the deduction is limited to $50,000. To make sure that we are specific, I am referring to one aspect of the deduction only and that is when you refinance or borrow more from your mortgage.

Like everything in life they give you something and then take it away.

The example below explains this in more detail

Let’s assume that you bought your home for $300,000. After a few years you currently owe $260,000 on your home.

Now assume at this point in time you decide to borrow against your home and take out an additional $30,000 from your HELOC. The key question is, are you allowed to deduct the interest paid on the $30,000 as a mortgage interest tax deduction? Let’s make one more assumption that your home is valued at $320,000 the day you decide to borrow money from your HELOC.

There is some bad news to this. The IRS does not allow you to deduct the entire interest on the $30,000.

You need to do a second quick calculation to find out the difference between the market value of your home and the costs plus improvements. In this example your market value is $320,000 and the cost is $300,000 so the difference is $20,000. This means is that even though you are allowed to claim up to $100,000 the IRS limits this and tells you that you can only claim interest on $20,000. So if you borrowed $30,000 and used this for personal use, the tax deduction for interest can only be claimed on $20,000. The interest you paid on the other $10,000 is disallowed.

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.

How to tell if you are in a tax trap?

Go to the url or the unique links below and gain access to a quick and easy checklist. In this document, we have given you suitable points to consider preventing you from making unnecessary mistakes when filling in 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.