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What Does It Mean to ‘Substantially Improve’ Your Home?

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You may be thinking that it’s time to make some upgrades to your home. If you utilize a home equity loan (HEL) or home equity line of credit (HELOC) to finance home improvements on your house, you may even enjoy benefits in the form of tax deductions for the interest paid on the home equity loan or HELOC.         

However, homeowners planning renovations should know that, under the Tax Cuts and Jobs Act (TCJA), which was enacted in 2017 and is expected to go through 2025 unless extended, interest on these loans is not deductible unless the money is used to “buy, build or substantially improve your home.” As such, to claim those deductions, you’ll need to do more than just regular maintenance on your home. So what, exactly, counts as a “substantial improvement” to your home? Here’s what you need to know.

What are substantial home improvements?

To help you determine if your home renovations may quality for tax deductions if you use an HEL or HELOC to find them, the IRS makes a very clear distinction between “repairs” and “improvements.”

As they apply to general maintenance and upkeep of your home, repairs alone do not qualify as a “substantial improvement” to the property.

For instance, repainting the home, replacing broken windows or fixing leaks are deemed necessary for the “ordinary, efficient operating condition” of the home, per the IRS. On the other hand, “substantial improvements” seek to increase the value of your home, or prolong its life.

These “substantial improvements” range from making your basement into an in-law apartment, to replacing the roof, to repaving the driveway or remodeling your kitchen. Use a home equity loan or HELOC to pay for these projects, and, if you itemize, you may deduct the interest from these loans on your taxes.

Keeping track of home improvements

When claiming interest deductions for home equity loans or HELOCs used to pay for substantial home improvements, it’s important to keep detailed records of these expenses should you need to verify your claim. These records should include all contracts and statements of work with building contractors, receipts for purchases and completed work, canceled checks and credit card statements for supplies and payments for work and additional paperwork detailing the improvements made to your home.

How you record and track your expenses for your home improvements is up to you, but all records must be thorough, easy to understand and accurate. The IRS makes it easy for you by providing a “Record of Home Improvements” worksheet where you can record the dates and costs for many specific types of home improvements. It’s important to note this worksheet is not exhaustive, and some items listed individually may not qualify as a “substantial improvement” on their own.

For instance, the list includes “lighting fixtures.” If you replace the lighting fixture in your kitchen because the previous one stopped working, or you found one you liked better, that would fall under “repairs” and would not qualify for a deduction if an HEL or HELOC is used to fund the purchase.

However, if you install new light fixtures as part of a new garage you add to the property, they would be included in the “substantial improvement” category, thus making those expenses eligible for the deduction.

Be sure to hold onto these records beyond the time you file your taxes. In general, the IRS recommends keeping records that support a tax deduction for three years from the date you filed your return if expecting a credit or refund, and two years from the date you filed your return if you paid tax.

However, those records may also be necessary to help establish your home’s value, which means you should keep them much longer. Therefore, it’s recommended you keep the records for as long as you own the home.

How does the deduction work?

When it comes to claiming the interest tax deduction from home equity loans or HELOCs, first and foremost those loans must have been used to pay for substantial home improvements, as outlined above. In addition, it’s important to know there is a limit to how much total debt you can have on the home in order to deduct interest from home equity loans on your taxes.

If your mortgage and home equity loan was taken out on or before Dec. 15, 2017, you can deduct interest on up to $1 million in qualifying debt if filing married or individually ($500,000 if married filing separately).

Under the TCJA, for any loans taken out after Dec. 15, 2017, single and married homeowners can deduct interest on up to $750,000 ($375,000 if married filing separately) in qualifying debt. If your total mortgage and HEL or HELOC debt adds up to $750,000 or less, you can deduct for both loans, as long as the home equity debt is used for those substantial improvements.

It’s also important to understand that you must itemize on your taxes in order to claim a deduction for a HEL or HELOC for substantial home improvements. The new tax law puts the standard deduction at $12,000 for singles and married filing separately, and $24,000 for married filing jointly. This is double what it was before the law was passed. Because of the increased standard deduction, fewer Americans are expected to itemize overall.

The bottom line

If you are considering making big changes to your home, such as finishing the basement or remodeling the kitchen, it’s possible you may receive a tax benefit from using a home equity loan or HELOC to pay for those improvements. Those who itemize on their taxes may recoup some of the money used by deducting the interest on their loans. Of course, in order to do so, you must meet specific conditions, so take a close look at those requirements before moving ahead with your renovation plans and in your tax preparations.  

To read more about loan options for home renovations, click here.  


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