Securing a home improvement loan can be the first step to increasing property values, or creating the home of your dreams. Unlike a home equity line of credit, a home improvement loan isn’t usually tax deductible. If the home equity loan is unsecured, it’s unlikely you’ll be able to take a tax deduction. However, if you have a HELOC or other home equity loan, you could deduct interest.
Read on to understand the answer to “Is home improvement loan interest tax deductible?” for your situation.
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Understanding home improvement loans
Home improvement loans are any type of loan used for home renovations. While home equity loans, or home equity lines of credit, require equity in your home for backing, other home improvement loans are unsecured and don’t require equity.
You can get home improvement loans from online lenders, banks, and credit unions. These are usually a form of unsecured personal loan marketed specifically to borrowers interested in home improvements. You will need to meet individual lender requirements. Once approved, you’ll receive a lump sum to use for renovations or anything else you need.
While home improvement loans are most commonly available to borrowers with good to excellent credit, some lenders will give these loans to borrowers with poor credit or no credit.
The fact that unsecured loans or debts like home improvement loans aren’t secured by a house or property means they’re not eligible for the tax credits, even if the loans are used for home improvement projects.
Home loans eligible for tax deductions
The following home loans may be partially eligible for a tax deduction, such as deducting interest payments. You can also learn more about personal loan taxes.
1. Home equity loans
Home equity loans are a type of secured loan backed by the equity you’ve built up in the home. They are a type of second mortgage and have strict usage restrictions and come with higher risk for lenders.
As a borrower, if you fail to make the payments, you risk losing your home. However, securing a home equity loan can be easier if you’ve built up home equity. You can also usually deduct interest payments on home equity loans as they’re considered a type of second mortgage. As long as you use the funds to improve your home substantially, you may be able to deduct interest from your loan.
Home equity loans usually have fixed interest rates and repayment terms of 15 to 30 years. You can choose a repayment plan that fits your needs and may be able to repay the loan sooner. The maximum you can borrow with a home equity loan depends on how much equity you’ve built up in the property and individual lender policies. Lenders typically will offer up to 85% of the equity you’ve built in the home, but individual policies vary.
2. Home Equity Lines of Credit (HELOCs)
Home equity lines of credit, or HELOCs are different from home equity loans. HELOCs allow you to borrow against the equity you’ve built up in the home. However, unlike a home equity loan that gives you a lump sum, you can withdraw funds over time with a HELOC. You can take out as much as you need, with no obligation to take more. This makes HELOCs a good choice for ongoing or long-term home improvement projects.
Usually, HELOCs include checks or a credit card that you can use to spend as needed within a specified time, known as the “draw period”. During the draw period, you only need to make minimum payments. Then, during the repayment period, you’ll need to pay back the borrowed funds plus interest, usually on a set repayment schedule.
HELOCs usually come with variable interest rates, but you might be able to secure a fixed interest rate on your outstanding balance. Interest on HELOCs is usually eligible for a tax credit when used for eligible projects.
Home improvement (renovations) vs. home repairs
The difference between home improvements or renovations and home repairs comes down to the purpose. A home improvement is an upgrade or change to the property that improves its intrinsic value or comfort. In contrast, repair is the maintenance of existing structures to keep them in working order.
For example, home repairs might include fixing a leaky roof or repairing an HVAC system with issues. Renovations include major improvements such as replacing a bathroom, re-doing a kitchen, adding an extension, or installing a pool or solar panels. A renovation may include repairs, but the purpose is more than repairs; instead, it focuses on refreshing or renewing the property with updates.
Tax-deductible home improvements
Certain home improvements may be eligible for tax benefits regardless of the type of loan you take out. Even if you use a home equity loan for financing, not all home improvement projects qualify for a tax deduction. It’s important to check the IRS website for current guidelines on home improvement deductions.
While it’s essential to speak with a CPA or tax professional to confirm your eligibility, the following may be tax-deductible or qualify for tax credits.
1. Home office deductions
If you work from home and have a dedicated workspace, you may be able to deduct the proportionate costs. This only applies to self-employed individuals or business owners. You cannot take this deduction if you’re an employee of another company working from home.
Interestingly, the term “home office” is broad. A boat, RV, mobile home, unattached garage, studio, or even barn might qualify if it’s strictly used for business. To qualify for this deduction, you must meet other IRS criteria.
2. Energy-efficient installations
Energy-efficient equipment like heat pumps, solar panels, energy-efficient windows, biomass equipment or small wind turbines may qualify for a tax break. You can even get a possible credit for energy-efficient air conditioning or water heaters.
The Residential Clean Energy Property Credit applies to qualifying eco-friendly renovations made between Dec. 31, 2021, and Jan. 1, 2033. You could be eligible for a tax credit of up to 30% of the total equipment costs. Specific criteria vary by the type of equipment installed, and you may have to spread deductions over several years.
3. Medical-related home renovations
Medical-related home renovations include installations necessary for medical care for you, your spouse or dependents. These renovations typically don’t increase the property value but are medically necessary. Common medically-related renovations include:
- Adding ramps or wheelchair lifts
- Modifying stairwells.
- Widening hallways and doorways.
- Installing wheelchair or differently-abled access for bathrooms, kitchen cabinets, appliances, electrical outlets, or specialized plumbing systems for a person with a disability.
If you’ve made these types of upgrades, you may qualify for a tax break as long as the additions fall within certain parameters. Of course, architectural or aesthetic changes and medically necessary renovations won’t be considered deductible. Before making renovations, speak with a CPA to understand what is deductible.
Tax-deductible home repairs
Capital improvements add value to your home, prolong its life or adapt it to new uses. These improvements include major renovations like
- Swimming pool
- A new deck
- Storm windows
- An intercom system
- A home security system
- New roof
- New central air-conditioning system
- An extra water heater
- Upgrades to heating or cooling systems.
Capital improvements aren’t deductible in the year you make them and instead are only deductible from your cost basis when you sell the property. Keep clear records and speak with a tax advisor about the cost basis and any possible deductions when you plan to sell.
Should You Take a Loan for Home Renovations?
A home equity loan, HELOC, or home improvement loan offers access to funds when you need it. You can also consider online personal loans or personal loans for bad credit. With a clear strategy, quotes from reliable contractors for your budget, and estimates about the added value of your renovations, home renovations can add more than comfort to your home. They can be a smart financial choice while adding comfort to your family’s unique needs.
FAQ
Are there limitations on the amount of interest that can be deducted for home improvement loans?
Yes, there are limits on the amount of interest you can deduct. You can deduct interest from a home equity loan unless it’s more than $375,000 for single filers or $750,000 for joint filers.
Do I need to itemize my deductions to claim the tax deduction on home improvement loan interest?
Yes, you generally need to itemize deductions to claim home improvement tax deductions.
Can I claim the tax deduction for home improvement loan interest if the improvements were made in a previous tax year?
If you’re still paying interest on the home improvement loan in the current tax year, you should be able to deduct the interest payments. Speak with a tax advisor or CPA to understand the implications of your situation.
