Have you ever refinanced your home, used the proceeds for personal use, and then claimed a tax deduction for the interest? I have some bad news. The IRS limits the amount you can claim as an interest deduction for tax purposes.

Are you confused by what this means to you.

It is not your fault. You are not alone. We are told that HELOC interest is deductible for tax purposes but sometimes, especially in this economy, this may not be the case, and you could land up in serious trouble with the IRS.

When you refinance on your home and use the money for any reason other than home improvement, the IRS limits your deduction for interest. In some cases you won’t be able to claim the deduction at all.

Well, the way this is set up, the IRS in general does allow you to deduct interest on your HELOC for tax purposes. They call this the home equity indebtedness deduction.

The home equity indebtedness means:

If you are married and file a joint return you are generally allowed to claim a deduction interest up to $100,000 of the funds you borrowed. If you file separate tax returns the limit is $50,000. I am only referring to one aspect of the deductions here which relates to refinancing or borrowing extra from your mortgage. There are other deductions and incentives so please consult your advisor.

Like everything in life they give you something and then take it away.

Let us see how this works through the example below

Let us make an assumption that you owe $260,000 on your mortgage and that you bought your home for $300,000.

Now assume at this point in time you decide to borrow against your home and take out an additional $30,000 from your HELOC. The key question is, are you allowed to deduct the interest paid on the $30,000 as a mortgage interest tax deduction? Let’s make one more assumption that your home is valued at $320,000 the day you decide to borrow money from your HELOC.

There is some bad news to this. The IRS does not allow you to deduct the entire interest on the $30,000.

Here is how the IRS limits your deduction. Take the current value of your home and deduct the cost. So $320,000 less $300,000 is $20,000. So what this means is that you can only claim the interest payments up to $20,000 and not $30,000 resulting in a smaller refund. This only applies if you borrowed extra money and used this for personal use.

Now here is some bad news especially in this economy where home prices have fallen really steeply. If the value of your home is less than what you paid for it and you borrowed money from your HELOC for personal use, the IRS prevents you from claiming a tax deduction for the mortgage interest. Let us say your home is worth $300,000. It is value at $285,000 today. You borrowed $30,000 from your HELOC for personal use. The interest paid on the $30,000 is not deductible for tax purposes. If you have claimed this deduction in the past or plan to claim this in the current year, please do not. You could end up with penalties and extra fines.

How to tell if you are in a tax trap?

Go to the url or the unique links below and gain access to a quick and easy checklist. In this document, we have given you suitable points to consider preventing you from making unnecessary mistakes when filling in your tax return.

I strongly recommend you contact your advisor or if you plan to refinance your mortgage, keep detailed records so you can claim the correct deduction.

Please note that this article is for informational purposes only. No liability is assumed with the information presented above.

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