Can i claim HELOC loan used for improving primary residence this year when i inadvertently said 'no' to it last year?

[Sri16]

I took out a HELOC loan late in 2022 and for the 2022 tax year, i inadvertently said No to the question on if the amount of debt was used to buy, build or substantially improve the home. This year (2023) I actually did use the amount for home improvement and want to change my response to 'Yes' for usage for home improvements. Would it be okay to have said No last year and change it to Yes this year? Shiould i amend my returns for last year? if not, will there be audit questions?

[DawnC]

You can claim qualified mortgage interest this year, whether you claimed it last year or not.   As long as you can show that you used the proceeds to buy, build, or substantially improve the home, an IRS inquiry would not be an issue.   See below for more information on this requirement.  

In most cases, you can deduct your interest. How much you can deduct depends on the date of the loan, the amount of the loan, and how you use the loan proceeds.

Some other conditions that must be met (there are more here:(

• The loan or line of credit is secured (put up as collateral to protect the lender) by your main home or a second home.
• The loan or line of credit must be used to buy, build, or substantially improve your home.  
• You can only deduct the portion of the loan or line of credit you used to buy, build, or substantially improve the home that is used to secure the loan or line of credit.   If you’ve ever used part of this loan to pay for things other than this home, you cannot deduct the interest from that amount of the loan, even if the transaction didn’t take place this year.

From Pub 936 -  A mortgage secured by a qualified home may be treated as home acquisition debt, even if you don't actually use the proceeds to buy, build, or substantially improve the home. This applies in the following situations.

1. You buy your home within 90 days before or after the date you take out the mortgage. The home acquisition debt is limited to the home's cost, plus the cost of any substantial improvements within the limit described below in (2) or (3). 
2. You build or substantially improve your home and take out the mortgage before the work is completed.  The home acquisition debt is limited to the amount of the expenses incurred within 24 months before the date of the mortgage.
3. You build or substantially improve your home and take out the mortgage within 90 days after the work is completed.  The home acquisition debt is limited to the amount of the expenses incurred within the period beginning 24 months before the work is completed and ending on the date of the mortgage.   Examples

[Opus 17]

The IRS will not object if you change how the HELOC was used.  However, as pointed out, if you take out a loan on your home, improvements are only qualifying if made within 24 months of taking out the loan.  Improvements after that do not qualify as acquisition costs for the interest deduction, even if you used the loan for actual improvements. 

[zomboo]

If you have used some draws on the HELOC for things other than the Home that secures the debt, you may have a mixed-use mortgage. Let the community know if you need help figuring that out.

[Sri16]

Thank you - my confusion was - in the Pub (and in comment abve) it states that improvements are only qualifying if made within 24 months BEFORE out the loan or 90 days after. However, i ended spending the proceeds more than 6 months after taking out the loan.. is that okay?

[Sri16]

Thank you - my confusion was - in the Pub (and in comment abve) it states that improvements are only qualifying if made within 24 months BEFORE out the loan or 90 days after. However, i ended spending the proceeds more than 6 months after taking out the loan.. is that okay?

[zomboo]

No. Since you took the loan out before completing the improvement, the qualified expenses are limited to a 24 month period before taking out the loan. You cannot deduct the interest related to this expense as a mortgage interest deduction.

[DawnC]

No, the proceeds would need to be spent on the improvement within the timeframes to be considered qualified interest.   #2 above:  You build or substantially improve your home and take out the mortgage before the work is completed >> The home acquisition debt is limited to the amount of the expenses incurred within 24 months before the date of the mortgage.  Answering NO last year was the appropriate response if the $$ was not used for improvements.   Had those funds been used within 90 days of the loan date, the interest would have been deductible.   For the interest to be deductible, the loan date would need to be within 90 days after the date the expense was incurred.  

Not deducting deductible interest last year does not prevent you from deducting deductible interest this year.   In your case, however, the interest was not deductible in either year.  

[Opus 17]

@Sri16 

This is a very confusing section of the publication, and I wonder if it correctly summarizes the regulation.

2. You build or substantially improve your home and take out the mortgage before the work is completed.  The home acquisition debt is limited to the amount of the expenses incurred within 24 months before the date of the mortgage.

Let's break that down.  I sign a contract to remodel my kitchen on January 1, 2024.  I have to pay 1/3 down, 1/3 on start, and 1/3 on completion.  I take out a second mortgage on January 10, 2024.  I pay my contractor deposit on January 15.  Work starts on March 1 and I pay.  The job is completed on May 1 and I pay again.  If this rule is written correctly, NONE of my 2nd mortgage is acquisition cost, because none of the work was completed before January 1, 2024.

That does not seem correct.   And I don't think it is correct.  Let's go up the page a bit.

Home acquisition debt is a mortgage you took out after October 13, 1987, to buy, build, or substantially improve a qualified home

That seems clear that if I take out the second mortgage and use the proceeds to pay my contractor, then it must qualify because I used the proceeds to improve the home.

A little further down,

Any secured debt you use to refinance home acquisition debt is treated as home acquisition debt. However, the new debt will qualify as home acquisition debt only up to the amount of the balance of the old mortgage principal just before the refinancing. Any additional debt not used to buy, build, or substantially improve a qualified home isn't home acquisition debt.

This limitation clause makes no sense if rule #2 is controlling, because if rule #2 controls, then refinancing a home can never increase the acquisition debt even if you use the proceeds to pay for your improvements.   So there is no need to add the limitation clause.  The rule would simply be, "new debt will only qualify as acquisition debt up to the previous balance" and refinancing to make an improvement would never be deductible unless you paid for the improvement out of pocket first, and we know that doesn't happen, nor is it  the intent of the regulation.

Finally, we have to look at the header that precedes those rules.

A mortgage secured by a qualified home may be treated as home acquisition debt, even if you don't actually use the proceeds to buy, build, or substantially improve the home. This applies in the following situations:

So the special rules only apply if you don't use the funds to directly pay for your improvements, they only apply in situations where you borrow the money long before or long after the improvement.

In other words, the special rules set limits on your ability to borrow money and say that it retroactively applies to past improvements.   The special rules do not set limits on the standard case where you borrow money and use it to make improvements, the special rules only set limits on the special case where you borrow money and don't use it right away.  The special rules set limits on how far back you can retroactively claim that your loan paid for an improvement, and they set limits on how long you can hold the money in your mattress before you make the improvements.  But I don't think they apply to the "standard" case where you borrow money and use it to pay for your improvements in a reasonable time frame. 

[zomboo]

You got me thinking and I believe I owe an apology to @Sri16. I have a new understanding that I hope the experts will agree with.

I think it is reasonable to interpret 'expenses incurred' under Special Situations #2 as expenses that were paid out of pocket before taking out the mortgage. You basically have a 24 month window the span of which depends when the debt is assumed. If the debt is assumed before work is completed, the debt covers expenses already paid in the preceding 24 months. If the debt is assumed within 90 days after the work is completed, the debt covers expenses paid within 24 months before completion up to the date the debt was assumed.

Since this special situation covers expenses already paid, you could spend the proceeds of the new debt on whatever you want and it will count as acquisition debt up to the cost of buying or improving the home previously.

In the case of a cash-out refinance or HELOC, any money borrowed will be non-acquisition debt until spent to buy or significantly improve the qualified home. During this time, the loan is a mixed-used mortgage and interest on the non-acquisition portion of the debt cannot be deducted. The loan remains a mixed-used loan until the non-acquisition portion is paid down or used on improvements. So @Sri16 cannot deduct the interest paid for the six months the money remained idle but can once the it is spent on the improvement.