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Tax Benefits of a Home Equity Line of Credit
Author David Schneider | Aug 29,2007
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A home equity line of credit is a good choice for homeowners who are interested in liquefying their home's equity. The primary advantage of a home equity line of credit is its tax advantages. These advantages range from simple federal and state tax deductions to superior after tax interest rate savings on car loans and unsecured debt that are reorganized under a HELOC.
Federal Tax Deduction
The first tax benefit offered by a home equity line of credit is that its interest charges can generally be deducted from your federal income taxes. However, to take advantage of this benefit you will need to itemize your deductions. If you don't itemize your deductions on your federal return, then you will not be able to capture the tax savings offered by this financial product.
State Tax Deductions
Your ability to deduct the interest from your home equity loan on your state income taxes is going to depend on your state's tax laws. Most states that charge an income tax will allow you deduct the interest charges from a second mortgage. However, there may be limitations and restrictions that impact how much of the interest you can deduct.
Expanding Your Tax Benefits
Another way that you can take advantage of the tax benefits offered by home equity lines of credit is to reorganize your higher interest rate debts under your HELOC. By doing this, you will be reducing the actual amount of interest you are paying on these debts because of your tax reduction. For example, let's say that your federal tax rate is 25 percent, which your HELOC APR is 8.5 percent and you have a car loan with an APR of 12 percent. If you used funds from your HELOC to pay off your car loan you would reduce the amount of interest paid on your car loan by nearly 50 percent.
To figure out after tax savings for reorganizing your debt you will take the inverse of your federal tax rate (1-federal tax rate), multiply it by your HELOC APR and then subtract the APR from the loan you want to pay off with your HELOC. For the example above, the calculations would look like this: (1-.25) = .75 X .085 = .0635-.12 = -.0565. This is an APR savings of .0565.
Double Your Tax Benefits
If you are looking for ways to take advantage of tax benefits offered by your home equity line of credit, then you may want to look at the things you are using the money from your HELOC to finance. If you use funds from your HELOC to finance education expenses or medical expenses, then you will not only be able to capture tax savings on the interest that you pay, but you will also be able to create an education or medical tax deduction as well. If you own a business and you use your HELOC to finance your business costs, then you will be able to deduct the HELOC interest on your personal tax return and you will be able to deduct the business expenditures funded by your HELOC on your business tax return. |
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