The Tax Advantages of Home Equity

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The rent-vs.-buy debate has been a long-running one. But there is one advantage to owning a home that renters will never enjoy: the tax breaks that come with paying off a mortgage loan.

You might have heard of the mortgage interest deduction even if you haven't yet purchased a home. The deduction, a valuable one for homeowners, has been in the news lately as some economists call for its elimination or scaling back as a way to help chip away at the federal deficit.

The mortgage interest deduction, though, still remains, and it's still a valuable financial perk for homeowners.

The mortgage interest deduction

This tax break allows homeowners to deduct the mortgage interest that they pay each year on their home. And the best news? This tax deduction doesn't just come on your home's first mortgage loan. If you've taken out a home equity loan or a home equity line of credit, you might be able to deduct all or part of the interest you pay on these loans, too.

But before you claim your deductions, it's important to know the limits that come with them.

Limits

In general, individual homeowners and those married who are filing their taxes jointly can deduct the interest they pay each year on up to $1 million in combined home loans. Homeowners who are married but filing their income taxes separately can deduct the interest they pay each year on up to $500,000 in combined home loans.

There is a caveat attached to this, though: That up to $1 million, or $500,000, in combined home loan money must have been used to either buy, build or improve a house.

In any case, interest payments made on home loans above either $1 million or $500,000 -- depending upon how you file your taxes -- are not deductible.

It's important to note, too, that you can deduct the mortgage interest on loans made to purchase more than one home. But the combined limit on these homes is still $1 million or
$500,000 in mortgage loans. You can't deduct the mortgage interest payments on any home after your second.

Home equity loans and lines of credit

You can also deduct the interest payments you make on home equity lines of credit of home equity loans each year. But restrictions come here, too.

If you take out a home equity loan or line of credit to make a purchase not related to buying, building or improving a home, you can only deduct the interest payments on up to $100,000. So, if you take out a $150,000 home equity loan to pay for your children's tuition, you can only deduct interest payments made on the first $100,000 of the loan. If you take out that same loan to add a second-floor master-bedroom to your home, you can deduct the interest on the entire $150,000.

Claiming mortgage interest deductions can become complicated depending on the size of your mortgage and on what you use the money for. Your best bet is to meet with a knowledgeable financial planner or accountant before filing your tax return.