15.3 Home Equity Loans

Mortgages that are not used to buy, build or improve your principal residence and/or second home (these are acquisition debt; see 15.2), are considered home equity debt. Interest you pay on home equity debt of up to $100,000 ($50,000 if married filing separately) is generally deductible, but the debt limit may be smaller in some cases depending on the value of the residence and the amount of acquisition debt; see below. In addition, as discussed in 15.2, debt you incurred to buy, build or improve your home may also qualify as home equity debt to the extent that such debt exceeds the $1 million acquisition debt limit ($500,000 if married filing separately).

The limit on home equity debt secured by your first or second home (15.1) is the lesser of:

1. $100,000, or $50,000 if married filing separately, or
2. The fair market value of your principal residence and second home (15.1), reduced by the amount of acquisition debt (15.2) and by any “grandfathered” (pre–October 14, 1987) mortgages (15.1). According to the IRS, fair market value, acquisition debt, and grandfathered debt are determined on the date that the last debt was secured by the home.
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image Planning Reminder
Home Equity Loan To Pay Consumer Debts
Interest on consumer loans is not deductible but, within limits, you can deduct interest on a home equity line-of-credit mortgage to pay off existing consumer debts and finance future consumer expenses. Interest on a home equity loan is fully deductible for regular tax purposes if within the $100,000 limit, but the interest is not deductible for purposes of alternative minimum tax, unless the loan proceeds were used to improve your first or second home (23.2).
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If you have a second home as well as a principal residence, the above limitation under (1) and (2) applies to the total debt for both homes. Interest on a qualifying home equity loan is deductible regardless of the way you spend the proceeds, unless it is used to buy tax-exempt obligations (15.11).

On loans exceeding the home equity debt limit, interest may be deductible if the proceeds are used for investment or business purposes. Otherwise, interest on the excess is nondeductible personal interest.

EXAMPLES
1. You bought your house for $200,000 subject to a mortgage of $150,000. When the mortgage principal is $120,000 and the fair market value of the house is $210,000, you take out a home equity loan. Interest on a home equity loan of up to $90,000 is fully deductible. Qualifying home equity debt may not exceed the difference between the fair market value of the house ($210,000) and the current acquisition debt ($120,000). If the value of the house exceeded $220,000, you could have borrowed up to the $100,000 limit as a qualifying home equity loan.
2. The fair market value of your house is $200,000 and the current mortgage is $160,000. You may deduct interest on a home equity loan of up to $40,000 ($200,000 − $160,000).

A loan may qualify partially as acquisition debt and partially as home equity debt where part of it is used to refinance an existing acquisition debt. The refinanced amount is still considered acquisition debt. Debt in excess of the refinanced amount is either home equity debt subject to the $100,000 ceiling or home acquisition debt subject to the $1 million ceiling, depending on the way the proceeds are used (15.7).

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