Deductibility of interest on home equity line of credit loan

[mpsingh08]

A few years ago I used my home equity line of credit for purchasing other investment properties overseas. So I did not deduct any of the interest paid on that loan. In 2020, I made improvements to my residence (completely rebuilding a floor, buying new heat pump, etc), but did not deduct the interest for the funds used in that project. I paid off and closed the HELC in refinancing the mortgage loan of my residence in the year 2021. In preparing the tax return for 2021, TurboTax inquired about (1) the amount on HELC which was paid off in closing it (which was smaller than the amount at year end 2021), and (2) how much of HELC was used from the beginning for improvements to my residence. This resulted in deducting a portion of the interest paid on the HELC in the year 2021. I am wondering if this is appropriate. Any guidance will be truly appreciate. 

[Anonymous_]

Yes, to the extent the proceeds were used to buy, build, or improve your home.

[Opus 17]

Mortgage interest is not deductible even if used to buy, build or improve the home unless the loan is taken out around the same time as the improvement.  I would need to look up the exact details, but I believe you need to finish the improvement no more than 2 years after taking out the loan, or you must take out the loan within 90 days of finishing the work.  In this case, your deductibility depends whether you had a loan or a line of credit.  If you took out a fixed loan in (you said a few years ago so let's say 2017) and and used some for overseas investments and parked the rest of the money in a savings account, and then took it out of the savings account in 2020 for your improvements, then the interest is not eligible deductible mortgage interest.   However, if this was a line of credit, and you took new draws from the line of credit in 2020 to pay for the improvement, then a portion of the interest would be deductible mortgage interest since it was new money/new loan proceeds used for a home improvement less than 2 years before or 90 days after the improvement.

For 2020, you could deduct some of the interest, as well as in 2021.  Turbotax may not always figure this out correctly.  The best way may be to look at your monthly statements and figure out how much of the loan is qualifying so you can determine the percentage of qualifying interest.  As an example, if your HELOC balance was $50,000 of which $20,00 was used for the improvements, that's 40%, so 40% of the interest is a qualified tax deduction. 

Separatelty, you may be able to deduct the portion of the interest used to purchase investments, against the investment income.  This can be tricky, and if you did not claim the interest you would have to file some amended returns.  It also depends in this case on being able to accurately trace the dollars of interest you pay on the home loan to the investment.  Tracing is easy if you make a loan and use the entire proceeds to buy an investment; tracing becomes much harder to prove if you used parts of the loans for other things, like credit cards, vacation, and so on.

[Anonymous_]

A HELOC is a line of credit and it would be standard procedure to write a check (draw on the account) to pay for home improvements.

[Opus 17]

---

@Anonymous_ wrote:

A HELOC is a line of credit and it would be standard procedure to write a check (draw on the account) to pay for home improvements.

---

People don't always use terminology correctly.  Now the taxpayer knows the rule and can apply it to their situation. 

[mpsingh08]

Truly appreciate your very complete guidance! 

I regret having missed out on the possible deductibility of the HELOC interest on the investment property account. Wish I had your guidance a few years ago. My CPA friend advises not to bother with correcting previous returns because it will most likely result in an audit of the tax return, and the headache and time wasted in the audit is not worth it unless the tax savings in correcting the previous return would be very significant.