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EQUITY LOANS AND TAXES
Are you aware that your home is not just a form of shelter for you and your family, but can also serve as your own private bank? Get more info on why you should borrow against your home's equity.

You can receive a generous tax break when you structure the money you draw from your home. In fact, homeowners can typically deduct up to $100,000 in interest paid for an equity loan or line of credit.

It is important to note that there are many deductibility limits. In addition, it is possible for the alternative minimum tax to cancel out the benefits. Before your decide to tap into the equity from your home, it is important that you go over your total financial needs and your tax situation and determine if an equity loan is your best coarse of action.

A variety of different uses...
You can use the funds you receive from your equity loan for whatever your needs are including college tuition costs, home improvements and remodeling projects or consolidating unsecured debts.

...one large tax break
When discussing taxation and home equity, you typically examine the deductibility of the interest. As mentioned, the tax laws permit a borrower to subtract the interest on an equity loan up to $100,000, no matter how the funds are utilized.

However, it is important to note that whether or not the interest can be deducted, and how much, will depend on several variables. For example, a property's fair market value and any existing mortgage can affect the tax break a homeowner is entitled to.

When the total of all loans secured by a home, including all equity loans and the first mortgage, exceed the fair market value of the property's, the interest on the amount of debt that surpasses the home's value is not deductible.

For example, you have a $85,000 mortgage on your home, which is now worth $105,000. Your bank says you qualify for a 125 percent loan-to-value equity loan of $46,250 ($105,000 x 125 percent = $131,250 minus $85,000 left on your first mortgage = $46,250). You look to utilize this loan to pay for your son's school and to buy him his first car. You intend on taking advantage of the interest tax deduction since your loan use is easily below the $100,000.

Wait! Now is when the worth of your home comes into the picture. Under these circumstances, tax rules say that you can deduct interest on equity loans up to $100,000, or, when the total sum of all loans secured by a home is greater than its fair market value, on the equity amount that does not exceed the property's value, whichever is less. In this case, that's $20,000 ($105,000 minus $85,000).

Therefore, the total eligible tax deduction based on the example above would be $20,000. You are not able to deduct the interest on the $26,250 equity loan balance.

Home improvements = improved tax breaks
You are entitled to different tax breaks when you utilize your home equity loan for making improvement to your residency. In this instance, the equity funds are basically treated as first mortgages, otherwise known as acquisition indebtedness. As a result, you can deduct up to $1 million in mortgage debt.

For example, suppose you took out a $150,000 home equity loan to add an extension to your $600,000 home. You can deduct 100% of the interest paid on the loan. On the contrary, if you use the $150,000 for a lavish 'around-the-world' vacation, you would only be able to deduct the first $100,000 in interest paid.

You are never going to be required to document how you choose to spend the funds you receive from your equity loan. However, it is important that you keep comprehensive tax records in the even that you are audited by the IRS.

Additional equity loan considerations
Home equity borrowers need to be aware of alternative minimum tax (AMT) implications. It is possible that this parallel tax system can result in taxpayers losing deductions.

Under the AMT, the interest on acquisition-debt loans is still deductible. However, money secured by your home but utilized for nonresidential intents is not allowed.

Equity loan borrowers can also be affected by the tax gap -- money the IRS says it is owed, but which taxpayers have not paid. It is believed by tax officials that illegally claimed home-related tax deductions are a direct cause to this collection deficit.

If you are caught by the IRS for making incorrect claims on equity loan interest, you will have to pay it back, along with penalty fees and interest charges. Examine the section on understanding taxes

In conclusion...
Even though a home equity loan may appear as a small loan, you are still securing it with your residency. Therefore, if you fail to make payments, the bank will foreclose on your home. If you can't make your loan payments, there are steps you can take to avoid foreclosure.


Related Reading:
Owning a Home Means Tax Benefits
Homeowner Tax Myths
Home Equity Loans vs. Cash Out Refinancing


 


        


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