(There are some differences between loans and lines of credit, and rather than rewrite my entire answer, I have added some additional comments in between the lines.)
You can only deduct interest on acquisition debt. Acquisition debt is debt used to buy, build, or remodel your home. Your HELOC does not become acquisition debt until you actually use the money for remodeling. For example, suppose your existing mortgage is $150,000 and was all used to purchase the home. You refinance for $200,000. At that time, only $150,000 is acquisition debt, so only 75% of your interest is deductible. Then, six months from now, you use $30,000 to remodel. At that time, the $30,000 is includable as acquisition debt. Your acquisition debt is $180,000 so that 90% of your interest is tax deductible. But the interest only becomes tax deductible when the debt becomes acquisition debt.
Of course, if this is a line of credit and your initial draw only covers your acquisition debt, then 100% of the interest is deductible. And if you later draw money to pay for the remodeling costs, then all your interest is deductible acquisition debt at that point as well.
The tax code provides two methods for determining the percentage of deductible interest. You can either keep track of the percentage of acquisition debt for each month’s payment, or you can take the average of the first month and last month of the year. In the above example, if you take out the HELOC in December, your first payment would be due in January. Your 2022 starting balance would be 75% acquisition debt and your year end balance would be 90% acquisition debt, and if you take the average, which is 82.5%, that is how much of your 2022 interest you could deduct on your 2022 tax return. Or, you could track the deductible portion of your interest for each month.
There is a question about how long you have to pay for the improvement in order to include the loan balance as acquisition debt. One particular instruction suggests the time may be as short as 90 days. Other instructions suggest the time may be as long as two years. However, there must be a definite connection between the loan balance and the remodeling cost. If you put the money in a bank account and withdraw it to pay for the remodeling, that creates a definite connection. If you were to do something else like buy a car, and then you later took out a title loan on the car to pay for remodeling, you couldn’t claim that it was technically the HELOC that was paying for the remodeling.
And again, if this is a line of credit, making a new draw to pay for remodeling will show the definite connection. It is unclear to me whether the two-year rule would apply in that case. Although the line of credit might have been opened more than two years ago, if the new draw was used to pay remodeling costs at the time the remodeling was performed, that would be within both the two-year and 90 day time frames, so I think it would be considered deductible interest.
