Is Home Improvement Loan Interest Tax Deductible? A Comprehensive Guide

Home improvements can greatly enhance the comfort, function and value of your home. However, these projects can be quite expensive. Financing your renovations with a home improvement loan allows you to pay for upgrades over time rather than all at once. But is the interest on these loans tax deductible?

The short answer is no—for the most part, home improvement loan interest is not tax deductible However, there are some exceptions depending on the type of loan you use Let’s take a deeper look at the tax implications of different home renovation financing options.

Overview of Home Improvement Loan Types

There are several ways you can fund home renovations

• Home Equity Loan – A loan that uses your home as collateral. Interest may be tax deductible if used for home improvements.

• Home Equity Line of Credit (HELOC) – A revolving line of credit secured by your home equity. As with a home equity loan, interest may be deductible for home improvements.

• Cash-Out Refinance – Refinancing your mortgage for more than you currently owe. You can use the excess cash for renovations. Interest is likely tax deductible.

• Personal Loan – An unsecured loan based on your creditworthiness. Interest is generally not tax deductible.

• Home Improvement Loan – A loan specifically for renovations. Interest is typically not deductible.

• Credit Cards – High-interest credit card debt is never tax deductible.

Tax Deductibility of Home Equity Loans and HELOCs

Unlike most home improvement financing, interest paid on home equity loans and HELOCs may be tax deductible if the funds are used to substantially improve your home.

According to IRS Publication 936, to qualify for the home mortgage interest deduction, the loan must be secured by your main home or second home and used to buy, build or substantially improve the home. Home equity debt up to $100,000 also qualifies.

However, the Tax Cuts and Jobs Act of 2017 limited the amount of home equity interest you can deduct to the first $750,000 ($375,000 if married filing separately) of combined mortgage and home equity loan balances. This applies to both existing loans and new home equity debt taken out after December 15, 2017.

So in short—if you take out a home equity loan or HELOC to renovate your home, and the total of all your home loan balances is under the limit, the interest may be tax deductible. Be sure to consult a tax professional to understand how the deduction applies to your specific situation.

Why Personal Loans and Home Improvement Loans Aren’t Deductible

Personal loans and loans marketed specifically as “home improvement loans” are usually not secured by your home, so the interest is not tax deductible. The IRS does not allow you to deduct interest on unsecured debt, even if you use the funds for home renovations.

While it may seem unfair, there are good reasons for this distinction:

• Income tax deductions amount to indirect government spending. The government has an interest in encouraging homeowners to build equity in their homes through improvements. There is less public policy interest in subsidizing unsecured consumer debt.

• Home equity loans pose less default risk to lenders because they are backed by your home collateral. As a result, lenders can offer lower interest rates. Since the rates are lower, the tax deduction on home equity loans costs the government less than a deduction on higher-rate unsecured debt would.

• Allowing deductions on any unsecured personal loan used for home improvements would open the door to potential abuse of the tax code. It would be harder for the IRS to verify that the funds were actually spent on eligible home renovations rather than other purposes.

Special Case: Cash-Out Refinancing

A cash-out refinance, though not technically a home improvement loan, can be a way to tap home equity for renovations while retaining the tax deduction.

With a cash-out refi, you refinance your mortgage for more than you currently owe and take the difference in cash. This converts your home equity into tax-deductible mortgage debt, unlike a home equity loan or HELOC which stops being deductible once you hit the $750K limit.

Just be aware that refinancing has costs, including closing costs and potentially higher interest rates. Do the math to ensure it makes sense for your situation.

Tips for Maximizing Home Improvement Tax Deductions

If you want to finance renovations and minimize taxes, here are some tips:

• Take out a home equity loan or HELOC rather than an unsecured personal loan. Make sure your total mortgage and home equity debt remains under $750K.

• If tapping home equity, use the funds only for renovations that qualify as home improvements with tangible value, not minor repairs or maintenance. Keep all receipts.

• If you’ve already maxed out your home equity borrowing limit, consider a cash-out refinance to make interest deductible. But watch out for closing costs.

• Consult a tax professional to understand the rules and paperwork required to claim the deduction. Track all home improvement expenses carefully.

• Compare the home equity interest deduction to the standard deduction for your filing status. Claim whichever one results in a larger tax reduction.

Limits to the Home Mortgage Interest Deduction

While interest on a home equity loan or HELOC can potentially be deducted, there are some important limitations:

• The IRS considers interest deductible only for loans used to buy, build or “substantially improve” a home. Minor repairs or maintenance don’t qualify.

• Home equity debt counts toward the $750,000 cap on total mortgage balances for which you can claim the deduction. This limit took effect in 2018.

• Only interest is deductible, not principal payments on the loan. And you can only deduct interest you actually paid during the tax year, not future interest.

• If you used loan funds for both qualified home improvements and other purposes, you can only deduct interest on the portion used for renovations.

• Home equity interest can’t be deducted for costs that don’t improve the home itself, like landscaping or furniture.

Record-Keeping Tips

To claim a tax deduction on home equity debt, you’ll need to be able to prove to the IRS that the funds were used for qualified home improvements. Keep the following documentation:

• Detailed records of all home renovation expenses, including invoices, receipts and canceled checks.

• Home improvement contracts clearly describing the work performed.

• Loan documents showing interest paid, such as Form 1098 from your lender.

• Information tracking which loan proceeds were used for which home improvements.

Thorough record-keeping gives you the documentation necessary to reap all available tax savings from your renovations.

Alternative Ways to Deduct Home Improvement Expenses

If you used unsecured financing for renovations, all may not be lost from a tax standpoint. Here are some other ways you may be able to deduct home improvement costs:

Medical Expense Deduction

You can deduct home renovations, including unsecured financing costs, as medical expenses if the improvements are directly related to a medical condition. For example, installing wheelchair ramps or widening doorways for accessibility.

Strict rules apply, and only medical-related renovation costs exceeding 7.5% of your adjusted gross income can be deducted. Consult a tax pro for details.

Home Office Deduction

If you use part of your home regularly and exclusively for your business, you may qualify for the home office deduction, allowing you to deduct a percentage of renovation costs based on the square footage of your office space.

Capital Gains Tax Exclusion

While not a deduction, home improvements can reduce the capital gains tax you’ll owe when you eventually sell your home. Your tax basis is increased by what you spend on upgrades, decreasing your taxable profit.

Rental Property Deductions

For investment properties, renovations can be depreciated over 27.5 years. And interest on loans funding improvements is deductible without limits, even for personal loans or credit cards.

The Takeaway on Tax Deductions for Home Improvement Loans

• Interest on home equity loans and HELOCs that fund home improvements may be tax deductible up to the $750K debt limit.

• Personal loans and standard home improvement loans usually don’t qualify for tax deductions.

• Cash-out refinancing can allow you to access home equity in a tax-deductible way.

• Keep meticulous financial records to substantiate deductions and consult a tax professional.

• Look into medical expense deductions or capital gains reductions if you used unsecured financing.

With proper documentation and expert guidance, certain types of home improvement loan interest can be deducted—putting money back in your pocket. Just be sure to understand the complex rules.