How Does a HELOC Affect Your Taxes: Interest Deduction and $750K Cap

A HELOC affects your taxes in three ways: the money you draw isn’t taxable income, the interest you pay may be deductible if you used the funds to buy, build, or substantially improve the home securing the loan, and any balance your lender later forgives can be treated as taxable income. The deduction requires itemizing and is capped by an overall mortgage debt limit of $750,000. These rules, originally set by the 2017 Tax Cuts and Jobs Act, were made permanent in 2025 and apply for the 2026 tax year.

Drawing Money From a HELOC Is Not Taxable

Borrowed money isn’t income because you owe it back. Funds you pull from a HELOC are debt proceeds, and you don’t report them on your tax return regardless of the amount or what you spend it on. Repaying the principal isn’t deductible either. Only the interest portion of your payments can potentially qualify for a tax break, and only under the conditions below.

When HELOC Interest Is Deductible

HELOC interest is deductible only when the borrowed funds are used to buy, build, or substantially improve the home that secures the loan. The IRS treats this as “acquisition indebtedness,” meaning the debt is tied directly to acquiring or improving the property itself.¹ The line of credit must be secured by your main home or a second home. A HELOC against an investment property follows different rules.

Using HELOC money to pay off credit cards, cover tuition, buy a car, or take a vacation means the interest on that portion is not deductible. If you use part of a draw for a kitchen remodel and part for a vacation, split the interest. Calculate what percentage of the outstanding balance went toward the qualified improvement, and deduct only that share. The rest is personal interest and gets nothing.

What Counts as a Substantial Improvement

The IRS defines a substantial improvement as work that adds value to your home, prolongs its useful life, or adapts it to new uses.² Qualifying costs include building materials, architect fees, design plans, and building permits. Common examples: adding a room, replacing a roof, renovating a kitchen, or installing a new HVAC system.

Routine maintenance and repairs that keep the home in its current condition don’t qualify. Repainting a few rooms or fixing a leaky faucet won’t support the deduction. There is one nuance worth knowing: if painting is part of a larger renovation that qualifies as a substantial improvement, the painting costs can be included in the total improvement cost.² The test is whether the project as a whole materially changes the home.

You Have to Itemize

Mortgage interest, including HELOC interest, is an itemized deduction reported on Schedule A. You cannot claim it if you take the standard deduction. For 2026, the standard deduction is $16,100 for single filers, $32,200 for married couples filing jointly, and $24,150 for heads of household.³

This is where the math kills the deduction for many homeowners. Itemizing pays off only when your combined deductible expenses (mortgage interest, HELOC interest, state and local taxes capped at $10,000, charitable contributions, and qualifying medical expenses) exceed the standard deduction. A married couple with $18,000 in mortgage interest, $6,000 in HELOC interest, and $10,000 in state and local taxes has $34,000 in itemized deductions, which barely clears the $32,200 threshold. Their actual tax benefit from the HELOC interest is only the margin above the standard deduction, not the full $6,000.

Run the numbers before you spend hours tracking HELOC draws for tax purposes. If your primary mortgage interest and other deductions already put you comfortably above the standard deduction, the HELOC interest adds real value. If you’re hovering near the line, the deduction may not justify the recordkeeping.

The $750,000 Combined Debt Cap

Even when HELOC funds go entirely toward home improvements, the interest deduction is capped by an overall debt limit. Your primary mortgage balance and qualifying HELOC balance are added together. If that combined total exceeds $750,000, you can only deduct the interest on the first $750,000 of debt. For married taxpayers filing separately, the cap is $375,000.⁴

How that plays out: say you have a $680,000 mortgage and draw $120,000 on a HELOC for a major renovation. Combined acquisition debt is $800,000, which is $50,000 over the cap. You’d calculate the deductible portion as $750,000 divided by $800,000, or 93.75%. Only 93.75% of your total qualified interest across both loans is deductible.¹

Homeowners who took out their original mortgage on or before December 15, 2017, have a higher grandfathered limit of $1,000,000 ($500,000 if married filing separately).⁴ A HELOC opened later against that same home still counts toward the applicable limit, so the grandfathered treatment applies to the older mortgage debt while the HELOC gets measured against whatever cap room remains.

Records That Support the Deduction

The IRS doesn’t know what you spent your HELOC money on. Your lender sends Form 1098 reporting total interest paid, but that form says nothing about how the funds were used.⁵ Proving that every dollar went toward a qualifying improvement is on you.

The biggest mistake people make is depositing HELOC draws into a general checking account they also use for groceries, utilities, and everything else. Once the funds are commingled, tracing them to specific improvement expenses becomes hard. Open a separate account and use it only for HELOC draws and improvement payments. That makes the paper trail obvious.

Keep the following documentation, matched by date:

Monthly HELOC statements showing the date and amount of each draw.
Signed contracts, invoices, and receipts showing the work performed, amounts charged, and dates of payment.
Building permits, architectural plans, and inspection reports confirming the scope of the improvement.

Connect each draw to a corresponding expenditure. If you drew $25,000 on March 10 and paid a contractor $25,000 on March 14 for a roof replacement, those documents together tell a clean story. Gaps between draws and payments, or draws that don’t match any invoice, invite questions. The general IRS rule is to keep records supporting a deduction for at least three years from the date you file.⁶ Improvement costs also raise your home’s tax basis, so keep them until you sell and for three years after filing the sale return.

The 90-Day Timing Rule

You don’t have to open the HELOC before starting the improvement. IRS Publication 936 allows debt taken out within 90 days after a home improvement is completed to be treated as acquisition indebtedness, as long as the expenses were incurred within the preceding 24 months.² Pay for a renovation out of savings, open a HELOC within 90 days of completion, and the interest can still qualify. For ongoing construction, a HELOC opened before the work is finished can also qualify, limited to expenses incurred within 24 months before the mortgage date.

When Forgiven HELOC Debt Becomes Taxable Income

If your lender forgives or cancels part of your HELOC balance through a negotiated settlement, short sale, or foreclosure, the canceled amount is generally treated as taxable income.⁷ The lender reports the forgiven amount on Form 1099-C, and you include it on your return for the year the cancellation occurs.

A few exceptions can reduce or eliminate the tax. If you were insolvent at the time of cancellation, meaning your total debts exceeded the fair market value of your total assets, you can exclude the canceled debt from income up to the amount of your insolvency. Debt discharged in a Title 11 bankruptcy is also excluded. A federal exclusion for canceled “qualified principal residence indebtedness” was available through the end of 2025 but applied only to debt used to acquire the home, not to home equity debt used for improvements or other purposes.⁷ If you’re facing a possible cancellation, talk to a tax professional before agreeing to any settlement terms.

1
Office of the Law Revision Counsel. 26 USC 163 – Interest
2
Internal Revenue Service. Publication 936 – Home Mortgage Interest Deduction
3
Internal Revenue Service. Revenue Procedure 2025-32
4
Internal Revenue Service. Real Estate (Taxes, Mortgage Interest, Points, Other Property Expenses)
5
Internal Revenue Service. About Form 1098, Mortgage Interest Statement
6
Internal Revenue Service. How Long Should I Keep Records
7
Internal Revenue Service. Topic No. 431, Canceled Debt – Is It Taxable or Not?