Owning a home comes with many tax benefits, but knowing what is tax-deductible can be a little tricky. It gets even more complicated when you have a mixed- or dual-use property. We’re going to dive into the HELOC tax deduction for various types of home-sharing properties.
What is a HELOC (Home Equity Line of Credit)
Most people use a mortgage to purchase their home or rental property. Over time, your payments will increase your equity in the home, and it can go even higher if the property’s value appreciates.
To calculate your equity, deduct your mortgage principle from the current value of your home. The resulting figure is your personal equity in your home.
Equity is an asset, but it doesn’t give you any access to cash. Typically, you’d have to sell your home to convert your equity to cash, but that can be a major hassle.
Fortunately, HELOCs can help homeowners tap into their equity without selling their homes. A HELOC allows you to access the equity in your property without refinancing the entire loan or selling your property.
HELOC for Airbnb
For Airbnb properties, a HELOC makes a lot of sense for many reasons. They offer flexible repayment terms, such as monthly interest-only payments. But, you can make additional payments as you see fit. This is especially appealing for Airbnb hosts with varying monthly cashflows.
HELOCs provide a revolving line of credit, like a credit card, that you can use for anything. Unlike other types of loans, HELOCs don’t restrict how you can use the funds.
You can use the money for renovations, acquisitions, or even mortgage payments. You can also let the HELOC sit knowing the funds are there for a rainy day.
HELOCs are secured by your property, so they often carry lower interest rates than unsecured loans. Interest rates for HELOCs are usually just a few points higher than your primary mortgage, making them significantly lower than a personal loan or credit card. However, interest rates vary depending on the amount of equity you have in your property and your credit score.
HELOCs do not have fixed interest rates, so the variable rates may increase or decrease over time.
Is the Interest on a HELOC Tax Deductible?
Interest paid on a HELOC is generally tax-deductible. However, there are some rules for deducting the interest. In order to deduct the interest paid on a HELOC, you must spend the money on improving or repairing the property used to secure the loan.
Additionally, if the HELOC is on your primary residence or shared-used property, you can only use up to $750,000 of loans to calculate your itemized deductions. Rental properties or the rental portion of your residence are not subject to the same restriction.
If you use a HELOC on your primary residence to buy a rental property, the interest is subject to tracing rules, which means that you follow the money to see how the funds were used.
You can also use HELOC funds secured by your primary residence to buy an Airbnb property. In this case, the interest on the HELOC is deductible against your rental income. Conversely, if only a portion of the HELOC was used to purchase the investment property, then only a portion of the interest is deductible.
It’s worth noting here that the opposite doesn’t work – you cannot take out a loan against your rental property and use the interest as a home mortgage deduction.
HELOC Tax Deduction Rules 2022
The rules for HELOC tax deductions have remained the same since the Tax Cut and Jobs Act (TCJA) was implemented in 2022. Tracing rules are still in place, and they determine your HELOC deduction based on how you used the funds. A HELOC on a primary residence used to improve that home is subject to the $750,000 total loan limitation for deductible interest.
Home Equity Loans Tax Deduction
HELOCs and home equity loans both allow homeowners to tap into equity. However, there are some key differences between these two options.
Home Equity Loan vs. HELOC
HELOC act as a readily accessible line of credit, but the home equity loan comes as a lump-sum payment. Additionally, HELOCs have flexible repayment terms, but home equity loans have a fixed payment schedule like a mortgage. Sometimes, this set schedule can help you avoid final balloon payments, which HELOCs can sometimes carry.
Depending on whether interest rates are generally rising or falling, the home equity loan interest rate may be higher or lower than a HELOC. Rates also vary according to loan repayment terms and the loan’s amount in comparison to your total home equity.
Is Home Equity Loan Interest Tax Deductible?
Interest paid on a home equity loan follows the same rules for HELOC interest deductions noted above, including the limitation on total loan value and use of the funds.
Other HELOC Tax Considerations
When deducting the interest paid on a HELOC loan, it’s important to keep thorough records of how the funds are used to justify your deduction. You need to make sure that any funds borrowed against your primary residence meet the criteria of investment interest to be used against a rental property.
For mixed-used properties, keeping records that justify the allocation of interest between your residence and your rental is key to handling any potential audits.
Though HELOCs require careful record-keeping. However, potential deductions and additional flexibility make them an attractive option for real estate investors. They provide access to the equity in your properties with adjustment repayment terms. The variable interest rates on HELOCs should be carefully considered before using them to tap the equity in your property.
More Money-Saving Tax Tips
Our team at Shared Economy Tax can help you identify missed tax deductions that could save you thousands on your annual tax bill. Sign up for a one-on-one strategy session with one of our tax pros now to see how much you can save.