Do I Have to Pay Taxes on a Home Equity Loan?

Money you receive from a home equity loan is not taxable income. You borrowed it and you owe it back, so the IRS treats the disbursement the same way it treats any other loan. The tax question that actually matters is whether the interest you pay is deductible, and under current federal law it is deductible only if you used the borrowed funds to buy, build, or substantially improve the home securing the loan, and only on the first $750,000 of combined mortgage debt ($375,000 if married filing separately).¹

Why the Loan Money Itself Isn’t Taxed

When a lender deposits home equity loan or HELOC proceeds into your account, that money is not income. Borrowed money is never taxed at disbursement because you have an obligation to repay it. This holds true regardless of what you spend it on. A $100,000 HELOC used entirely for a vacation still produces zero taxable income from the loan itself.²

Two situations can change that picture: the deductibility of your interest, and what happens if the lender later forgives some or all of the balance. Both are covered below.

When the Interest Is Deductible

Interest on a home equity loan or HELOC is deductible only when the borrowed money went toward buying, building, or substantially improving the home that secures the loan. If the funds went to anything else, the interest is treated as personal interest, and personal interest is not deductible.³

Common uses that do not qualify include paying off credit cards, covering tuition or medical bills, buying a car, or investing in stocks. A $50,000 home equity loan used to consolidate credit card debt produces no deduction, even though the debt is secured by your home.¹

Before the One Big Beautiful Bill Act was signed in July 2025, many taxpayers expected an older rule to return in 2026, one that allowed a deduction on up to $100,000 of home equity debt regardless of use. That did not happen. The rule eliminating that deduction, originally in the 2017 Tax Cuts and Jobs Act, was made permanent.⁴

What Counts as a Substantial Improvement

The IRS defines a substantial improvement as one that adds value to the home, extends its useful life, or adapts it to a new use. A kitchen remodel, a new roof, a room addition, and a full window replacement all qualify. Routine maintenance like repainting a room does not, unless the painting is part of a larger qualifying renovation.¹

The burden of proof falls on you. Keep receipts, contractor invoices, and a clear paper trail linking the loan disbursement to the qualifying project. Without documentation, the IRS can reclassify the interest as non-deductible personal interest. Most challenges to the deduction fail at this step: the renovation happened, but the homeowner cannot tie the loan proceeds to the specific expenditure.

The $750,000 Combined Debt Cap

Even when the loan qualifies, the interest deduction is capped. You can deduct interest only on the first $750,000 of combined mortgage debt for joint filers, or $375,000 for single filers and married filing separately. This cap covers everything at once: your original mortgage, a home equity loan, and any HELOC balance.¹

Here is the math in practice. A couple has a $600,000 first mortgage and takes out a $200,000 home equity loan to build a garage. Combined debt is $800,000, which is $50,000 over the cap. They can deduct interest attributable to $750,000 of that debt. Interest on the remaining $50,000 is not deductible, even though every dollar went to a qualifying improvement.

Older mortgages get a different ceiling. If you took out acquisition debt on or before December 15, 2017, the cap on that older debt is $1,000,000 ($500,000 if married filing separately). Any new home equity debt taken out after that date still falls under the $750,000 rule, and the older debt reduces the room available under the newer cap.¹

Mixed-Use Loans

If you used part of a home equity loan for improvements and part for something else, only the portion of the interest tied to the qualifying use is deductible. The IRS requires you to trace the proceeds to each use and allocate the interest accordingly.

Say you took a $100,000 HELOC and spent $60,000 on a bathroom addition and $40,000 on a boat. Sixty percent of the interest is potentially deductible (subject to the $750,000 cap) and 40% is not.¹

One narrow exception: if the non-qualifying portion went to business or investment purposes, that slice of interest may be deductible under different rules, as a business or investment expense rather than as mortgage interest. Publication 936 points taxpayers in that situation to the interest allocation rules in the temporary regulations under Section 163.¹

Second Homes

A home equity loan or HELOC secured by a second home can qualify under the same use rules, provided the funds went to buy, build, or improve that second home. The $750,000 combined cap covers debt on your primary residence and one second home together, not $750,000 for each.¹

Whether the property qualifies as a second home depends on rental use. If you never rent it out, it qualifies with no minimum personal-use requirement. If you do rent it out for part of the year, you must use it personally for more than 14 days or more than 10% of the days it was rented, whichever is longer.¹

Points and Closing Costs

Home equity loans typically come with points, appraisal fees, and other closing costs. Points paid on a loan used for home improvements are generally deductible, but usually must be spread over the life of the loan rather than deducted in full the year you pay them. A full upfront deduction is reserved for points on a loan used to buy or build your principal residence, and even then only when several conditions are met, including that you provided funds at closing at least equal to the points charged.⁵

Most other closing costs are not deductible at all. Appraisal fees, notary fees, credit report charges, and mortgage note preparation costs cannot be claimed as interest or added to your home’s cost basis.⁶

How to Claim the Deduction

Deducting home equity loan interest requires itemizing on Schedule A of Form 1040. Itemizing only helps if your total itemized deductions exceed the standard deduction, which for 2026 is $32,200 for married couples filing jointly, $16,100 for single or married filing separately, and $24,150 for heads of household.⁷ For many homeowners with modest mortgage balances, the standard deduction wins, and the interest deduction delivers no actual tax benefit.

Your lender will send you Form 1098 by the end of January showing the interest you paid during the previous year. For a home equity loan or HELOC, the interest appears in Box 1.⁸ If your total mortgage debt is under $750,000 and you used the full loan for qualifying purposes, you can report the entire Box 1 amount on Line 8a of Schedule A.⁹

When Your Debt Exceeds the Cap

If your combined mortgage balances exceed $750,000, the Form 1098 amount will include some non-deductible interest. Use the worksheet in Publication 936 to calculate the deductible portion. The formula: divide $750,000 by your total average mortgage balance, then multiply the result by the total interest you paid.¹

For example, with an average combined balance of $900,000 and $45,000 in total interest, dividing $750,000 by $900,000 gives 0.833. Multiplying $45,000 by 0.833 gives $37,485 in deductible interest. The remaining $7,515 is non-deductible personal interest.

When Forgiven Home Equity Debt Becomes Taxable

The proceeds are not income, but if your lender later forgives, cancels, or settles the debt for less than you owe, the forgiven amount generally is taxable. The lender will issue Form 1099-C for any canceled debt of $600 or more, and the IRS expects you to include that amount as ordinary income.¹⁰

Exceptions exist. If you were insolvent immediately before the cancellation, meaning your total liabilities exceeded the fair market value of all your assets, you can exclude the canceled amount from income up to the extent of your insolvency. Home equity loans count toward your total liabilities for that calculation. You claim the exclusion by filing Form 982 with your return.¹¹

A separate exclusion for canceled qualified principal residence indebtedness applied through the end of 2025 but is not available for discharges on or after January 1, 2026, unless the discharge was subject to a written arrangement entered into before that date. For home equity debt forgiven in 2026 or later, the insolvency exclusion and the bankruptcy exclusion are the remaining paths to avoid taxation on the canceled amount.²

1
Internal Revenue Service. Publication 936 (2025), Home Mortgage Interest Deduction
2
Internal Revenue Service. Topic No. 431, Canceled Debt – Is It Taxable or Not?
3
Internal Revenue Service. Real Estate (Taxes, Mortgage Interest, Points, Other Property Expenses)
4
Office of the Law Revision Counsel. 26 USC 163 – Interest
5
Internal Revenue Service. Topic No. 504, Home Mortgage Points
6
Internal Revenue Service. Tax Information for Homeowners
7
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
8
Internal Revenue Service. Instructions for Form 1098 (Rev. December 2026)
9
Internal Revenue Service. 2025 Instructions for Schedule A (Form 1040)
10
Internal Revenue Service. About Form 1099-C, Cancellation of Debt
11
Internal Revenue Service. Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments