Can You Deduct Interest on a Home Equity Loan for a Rental Property? (2024 Guide)

Taking out a home equity loan against your rental property can provide useful capital for renovations, expansions, or other investments But before tapping into your property’s equity, it’s crucial to understand the potential tax implications One key question many rental property owners have is can you deduct interest on a home equity loan for a rental property?

The short answer is yes—under certain circumstances Let’s take a detailed look at how home equity loan interest can be tax deductible for rental properties,

Overview of Home Equity Loan Interest Deductions

The IRS generally allows deductions for expenses that are considered “ordinary and necessary” in operating a business or income-producing activity. Owning and renting out a property is treated as a business by the IRS. So expenses directly related to the property can be deducted against the rental income.

This includes deducting interest paid on debts and loans associated with the rental property. However, there are important caveats depending on the type of interest and how the loan funds are used.

Deducting Home Equity Loan Interest

Interest paid on home equity loans is deductible if the loan is used for expenses related to renting out the property. This includes:

• Interest on home equity loans used for rental property renovations or repairs
• Interest on a home equity loan used as part of the down payment to acquire a rental property
• Interest paid to refinance an existing rental property mortgage

However, the deductibility depends on properly tracking expenses and loan use:

• You must keep detailed records showing the home equity loan was used for legitimate rental property expenses.
• If you use the funds for both rental and personal purposes, you can only deduct interest on the portion used for the rental.
• You cannot deduct interest on home equity loan funds used for personal expenses.

Let’s look at some examples to illustrate deductible and non-deductible uses of home equity loan interest:

Deductible Interest Examples:

• Jim takes out a $50,000 home equity loan to renovate his rental property. He can deduct all interest paid on the loan.

• Sara uses a $75,000 home equity loan to purchase a rental property investment. The interest is deductible.

• Mark refinances his rental property mortgage via a cash-out refinance, pulling equity out of the property. The interest on the new loan is deductible.

Non-Deductible Interest Examples:

• Julie takes a $100,000 home equity loan and uses $40,000 to renovate her rental but spends the other $60,000 on personal expenses. She can only deduct interest on the $40,000 used for the rental.

• Tom uses a $35,000 home equity loan to pay off personal credit card debt. This interest is not deductible.

• Nancy takes out a home equity loan but does not use it for her rental property. The interest is not deductible.

As you can see, tracking the use of funds and maintaining documentation on all expenses is critical for claiming tax deductions.

Claiming the Home Equity Loan Interest Deduction

To properly claim deductions for rental property home equity loan interest, here are some key steps:

• Keep detailed records – Maintain receipts, statements, and documentation showing how much interest you paid and how loan funds were used for rental property expenses.

• Receive Form 1098 – Your lender will issue this form by January 31 showing mortgage interest paid the prior tax year.

• Deduct on Schedule E – Claim deductions for qualified home equity loan interest on Schedule E of your Form 1040 when filing your personal tax return.

• Know deduction limits – Your total deductions cannot exceed your rental income. Any excess can be carried forward to future tax years.

• Consult a tax pro – Consider having a tax professional review your return to ensure you’ve maximized legitimate deductions and properly followed all IRS rules.

Limitations and Considerations

While home equity loan interest is often deductible, there are some limitations and other factors to keep in mind:

• You cannot deduct interest on home equity debt used to buy personal property or other non-rental expenses.
• Your total rental property expenses, including interest, cannot exceed total rental income for the year.
• Interest deductibility could be impacted by tax law changes, so stay updated.
• Some alternative minimum tax rules may affect deductibility. Consult a tax pro regarding your specific situation.
• Weigh deductions against other factors when deciding whether to get a home equity loan or line of credit. Make sure it aligns with your investment goals.

The Bottom Line

With proper documentation and tracking of expenses, the interest on a home equity loan used for legitimate rental property expenses is generally tax deductible. But work with a tax professional and follow all IRS rules to maximize deductions and avoid problems. And most importantly, make sure the home equity debt aligns with your overall rental property investment strategy.

Frequently Asked Questions

How much of my home equity loan interest can I deduct?

You can deduct interest on the portion of the home equity loan used for rental property expenses. Keep detailed records showing the loan funds were used for expenses like renovations, repairs and operating costs.

What records do I need to keep for deducting interest?

You should keep all receipts, bank statements, loan documentation, Form 1098s showing interest paid, and expense records. These documents prove how the funds were spent and validate the amount of interest paid.

Can I deduct interest on a HELOC for a rental property?

Yes, a home equity line of credit (HELOC) is treated the same as a home equity loan. If you use the HELOC specifically for rental property expenses, the interest is deductible.

Is refinancing interest still deductible?

If you refinance an existing rental property mortgage, the interest on the new loan remains deductible, provided you continue using the property as a rental. Make sure to document the use of any cash-out proceeds taken during the refinance.

What if I use loan funds for personal and rental expenses?

You can only deduct interest on the portion of funds used for rental property expenses. Have clear records showing the allocation percentages and amounts for rental vs. personal use.

What happens if I exceed passive loss limits?

Your rental property deductions, including interest, cannot exceed your total passive income. Any unused passive losses can be carried forward to future tax years. Consult a tax professional for guidance on passive activity loss rules.

Key Takeaways:

• Interest paid on home equity debt used for legitimate rental property expenses is tax deductible.

• Proper documentation and tracking of loan use is required to claim deductions.

• Work with a tax professional to ensure you maximize available deductions and follow IRS rules.

• Make sure the home equity loan aligns with your overall rental property investment goals.

Frequency of Entities:

home equity loan interest: 17
rental property: 16
interest: 14
deductible: 10
loan: 10
expenses: 7
deductions: 6
property: 6
funds: 5
documentation: 4
mortgage: 3
refinance: 3
HELOC: 2
taxes: 2
equity: 2
repairs: 1
renovations: 1
improvements: 1
operating costs: 1