No, you do not have to pay taxes on a home equity cash-out. The money you receive from a home equity loan, HELOC, or cash-out refinance is borrowed, not earned, so the IRS does not treat it as income. The tax question worth your attention is a different one: whether the interest you pay on that debt is deductible, and that turns almost entirely on how you spend the cash.
Why the Cash Itself Is Not Income
Federal law defines gross income as “all income from whatever source derived,” a phrase that covers wages, business profits, investment gains, and dozens of other categories.1Office of the Law Revision Counsel. 26 USC 61 – Gross Income Defined Loan proceeds do not fit any of them, because a loan is not a gain. Every dollar the lender wires you comes attached to a matching obligation to pay it back. Your cash goes up, your liabilities go up by the same amount, and there is nothing new to tax.
This holds true regardless of how the money is structured. A lump sum from a home equity loan, a series of draws from a HELOC, or a larger new mortgage that pays off your old one and hands you the difference — all three deliver borrowed money, and none of the three shows up as income on your return. Your lender will not issue you a 1099 for the disbursement itself.
When Forgiven Home Equity Debt Does Become Taxable
The tax-free treatment rests on one condition: you owe the money back. If that obligation is erased through a short sale, foreclosure settlement, negotiated write-down, or lender charge-off, the forgiven amount generally becomes taxable income in the year the debt is cancelled. The lender reports it on Form 1099-C.2Internal Revenue Service. Home Foreclosure and Debt Cancellation
A special exclusion once shielded forgiven mortgage debt on a principal residence, but it applied only to discharges through December 31, 2025 and does not cover debt forgiven in 2026 or later.3Internal Revenue Service. Publication 4681 (2025), Canceled Debts, Foreclosures, Repossessions, and Abandonments Two exceptions still help some borrowers: debt discharged in bankruptcy is not taxed, and if you were insolvent when the debt was cancelled — total debts exceeding the fair market value of your assets — some or all of the forgiven amount can be excluded.4Internal Revenue Service. Topic No. 431, Canceled Debt – Is It Taxable or Not? Outside those situations, cancelled home equity debt is fully taxable.
When You Can Deduct the Interest
Interest on home equity debt is deductible only when the borrowed money was used to buy, build, or substantially improve the home securing the loan. The IRS is explicit that the use of the funds controls, not the fact that your house is the collateral.5Internal Revenue Service. Real Estate Taxes, Mortgage Interest, Points, Other Property Expenses Sixty thousand dollars from a HELOC spent on a kitchen renovation qualifies. The same $60,000 spent paying off credit cards does not.
The statute calls the qualifying category “acquisition indebtedness” — debt used to acquire, construct, or substantially improve a qualified residence.6Office of the Law Revision Counsel. 26 USC 163 – Interest Anything else — tuition, a car, medical bills, personal living expenses — falls outside it, and the interest attributable to that portion of the debt is not deductible.
This rule surprises borrowers who remember when all home equity interest was deductible regardless of use. That older rule ended with the Tax Cuts and Jobs Act in 2017, and the One Big Beautiful Bill Act made the restrictions permanent for tax years beginning after 2025.7Congress.gov. Tax Provisions in H.R. 1, the One Big Beautiful Bill Act
The $750,000 Debt Ceiling
Even when every dollar goes to qualifying improvements, there is a cap. Your combined mortgage debt used to buy, build, or improve cannot exceed $750,000 for married couples filing jointly, or $375,000 for single filers and those married filing separately.8Internal Revenue Service. Publication 936 – Home Mortgage Interest Deduction The limit applies across your primary and second home combined. Carry $850,000 in qualifying debt and only the interest on the first $750,000 is deductible.
Mortgages taken out on or before December 15, 2017 are grandfathered at the old $1 million cap ($500,000 for married filing separately). New home equity borrowing after that date is measured against the current $750,000 limit, reduced by whatever grandfathered balance remains.6Office of the Law Revision Counsel. 26 USC 163 – Interest If you still owe $700,000 on grandfathered debt, only $50,000 of new qualifying home equity debt generates deductible interest.
What Counts as a Substantial Improvement
The IRS distinguishes capital improvements from routine maintenance. Improvements add value, extend the home’s useful life, or adapt it to a new use. Maintenance keeps things running. Only the first qualifies.
- Additions such as a new bedroom, bathroom, or attached garage
- Major system replacements: roof, HVAC, plumbing, electrical wiring
- Gut renovations of a kitchen or bathroom
- New permanent features like a deck, fencing, built-in appliances, or a swimming pool
Repainting, patching drywall, fixing a leaky faucet, cleaning gutters — these are repairs. They keep the house in its current condition rather than improving it, and interest on money spent that way is not deductible.
Splitting a Mixed-Use HELOC
Plenty of borrowers use part of a HELOC for improvements and part for something else. When that happens, you have to trace which dollars went where and prorate the interest. The IRS requires the allocation to match the fraction of the loan used for qualifying purposes.9Internal Revenue Service. Publication 936 (2025), Home Mortgage Interest Deduction
Draw $80,000, spend $50,000 on a bathroom addition and $30,000 on a car, and 62.5% of the interest is potentially deductible. The math has to be redone as balances change, which gets messy quickly on a revolving line. When you pay principal down on a mixed-use balance, the IRS applies the payment first to the non-qualifying portion, then to grandfathered debt, and finally to acquisition debt.9Internal Revenue Service. Publication 936 (2025), Home Mortgage Interest Deduction
The cleanest defense is separation: keep qualifying and non-qualifying draws in different accounts so the paper trail is obvious. If that is not practical, tie every draw to a specific expense in your records.
Cash-Out Improvements Raise Your Cost Basis
Money spent on capital improvements increases your home’s cost basis — the number the IRS uses to calculate your gain when you sell.10Internal Revenue Service. Publication 551, Basis of Assets A higher basis means a smaller taxable gain.
Buy for $400,000, spend $80,000 of HELOC cash on a major renovation, and your adjusted basis is $480,000. When you sell, gain is measured from $480,000, not $400,000. If you qualify for the home sale exclusion, up to $250,000 of gain ($500,000 for married couples filing jointly) is excluded from income.11Internal Revenue Service. Topic No. 701, Sale of Your Home The basis boost matters most when your gain is approaching or exceeding those thresholds. Keep every receipt, contract, and permit; the burden of proving basis falls on you if the IRS ever asks.
Itemizing Is the Prerequisite
None of the interest deduction rules do anything for you unless you itemize on Schedule A. For 2026 the standard deduction is $32,200 for married couples filing jointly, $16,100 for single filers and those married filing separately, and $24,150 for heads of household.12Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Your mortgage interest only helps if it plus your other itemized deductions — state and local taxes (capped at $10,000), charitable contributions, and the rest — exceeds that figure.
For many borrowers with modest loan balances, the standard deduction wins. If you are pulling cash out mainly because you expect a tax break on the interest, run the numbers first. If your itemized total will not clear the standard deduction, the deductibility rules are academic.
Records the IRS Will Expect
Your lender reports interest paid on Form 1098 and sends a copy to the IRS.13Internal Revenue Service. Instructions for Form 1098 The form shows what you paid, not how you spent the borrowed money, and the form itself warns that the amount shown may not be fully deductible because of limits based on loan amount, property value, and use of proceeds.14Internal Revenue Service. Form 1098 – Mortgage Interest Statement Applying the qualifying-use test, the debt cap, and any mixed-use allocation is on you.
Keep contractor invoices and contracts, building permits, before-and-after photos, HELOC or bank statements showing each draw with its date, and proof of payment linking each draw to a specific improvement expense. If a return is questioned years later, that file is the difference between a confirmed deduction and a disallowance with interest and penalties on top.