How to Deduct Home Equity Loan Interest

Each year when tax season rolls around, homeowners tend to go into a frenzy trying to decipher all the new tax laws and which of those new laws apply to them. It is possible that you may want to deduct home equity loan interest when doing taxes, but then again, there are times when it may not be your best alternative. Basically, if your itemized deductions will be larger than the standard annual deductions established by the IRS, then you would be able to take the home equity loan credit when filing your taxes.

Step 1: What You Will Need

Before you sit down to do your calculations, gather all the items together that you will need so that you can just focus on the task at hand. Have all your financial papers on hand, a calculator, pens, paper, and of course IRS Publication 936 Home Mortgage Interest Deduction which can be downloaded from the Internal Revenue Website. Some people like to have a personal computer or laptop available with tax software to help with the calculations. It is always best to keep a checklist of what you will need so that you are not distracted while making calculations. Every distraction leaves room for error.

Step 2: Calculating the Allowable Amount of Home Equity Interest

In order to weigh standard deductions against itemized deductions, begin by figuring how much of your home equity loan interest is deductible. There is a flow chart on page 3 of Publication 936 that will help you determine if all of your home equity interest is deductible, and if not, what portion would be. This amount would be added to state and local income taxes, charitable donations and real estate taxes to obtain your final deduction. One word of advice here – if your home equity loan mortgage carries variable home equity loan interest rates, make absolutely certain you are using the current year’s interest paid!

Step 3: Find the Current Year’s Standard Deductions

The United States federal government is prone to making last minute changes to their tax laws, so it is vitally important to make sure you are working with the current year’s standard deductions. For instance, in 2009 the standard deductions for an individual were $5,700 for a single taxpayer, $11,400 if married and filing jointly and $8,350 for all taxpayers filing as head of household. Standard deductions may be higher if you are over 65, legally blind, or have a spouse who fits those criteria. Remember, these figures are based on 2009 tax tables, so you should always check the current year’s standard deductions before doing calculations.

Step 4: Taking the Appropriate Deduction

Once you have determined that your itemized deductions would be larger than your standard deduction for the tax year in question, it’s time to learn how to deduct home equity loan interest along with any other deductions on your tax return. For this you would need Schedule A which can also be obtained from the IRS website. All the information you will need to itemize would be in the third section. There are other things you can deduct here such as points and origination fees that were involved in obtaining the home equity loan mortgage. Only points paid on monies used for improvements to your homestead (primary home) can be fully deducted for the tax year. All other points must be amortized.

When trying to figure out how to deduct home equity loan interest on your next year’s tax return, just take a deep breath and follow these instructions. If you have any questions, or are uncertain, most information can be found on the IRS website. Just remember the one rule of thumb. You will be taking the deduction that is largest, so calculate carefully as it affects your bottom line!