Is a Line of Credit Taxable Income or Tax Deductible?

Money you draw from a line of credit is not taxable income, and whether a line of credit is tax deductible depends entirely on the interest, not the principal. Loan proceeds don’t count as income because you owe them back. The interest you pay may be deductible if you used the borrowed money for home improvements on the property that secures the loan, for business operations, or for taxable investments. Use the money for personal spending and the interest gives you nothing at tax time.

Why the Money You Borrow Isn’t Income

The IRS defines gross income broadly as “all income from whatever source derived,” listing wages, business profits, rents, and cancelled debt, among others.¹ Loan proceeds are not on that list. When you draw on a line of credit, your net wealth doesn’t change: you get cash, and you take on an equal obligation to repay it. The rule applies the same way to HELOCs, business credit lines, and unsecured personal lines of credit.

When a Line of Credit Becomes Taxable: Cancelled Debt

The picture changes the moment a lender forgives what you owe. You kept the cash and no longer have to give it back, so the forgiven amount is income. The IRS states plainly that “if your debt is canceled, forgiven, or discharged for less than the amount owed, the amount of the canceled debt is taxable.”²

When a creditor cancels $600 or more, they send you and the IRS a Form 1099-C showing the amount and the date.³ You report it as income unless one of the statutory exclusions applies.⁴

Debt discharged in a Title 11 bankruptcy is fully excluded.
If your total liabilities exceeded the fair market value of your assets immediately before the cancellation, you can exclude the cancelled amount up to the extent of that insolvency.
Certain forgiven mortgage debt on a primary home qualifies if discharged before January 1, 2026, or under a written agreement entered before that date.

Insolvency gets missed most often. Add up everything you own (including retirement accounts and exempt assets) and everything you owe. If your liabilities top your assets by $30,000, you can exclude up to $30,000 of cancelled debt.⁵ You claim any of these exclusions on Form 982 and reduce certain tax attributes as required.⁶

HELOC Interest: Deductible Only If You Improved the Home

Interest on a home equity line of credit is deductible only when you used the borrowed money to buy, build, or substantially improve the home that secures the loan. Spend HELOC funds on anything else and the interest is nondeductible personal interest, even though your house is collateral. In the IRS’s words, “you can no longer deduct the interest from a loan secured by your home to the extent the loan proceeds weren’t used to buy, build, or substantially improve your home.”⁷

The Tax Cuts and Jobs Act of 2017 introduced this restriction and was set to expire after 2025. The One Big Beautiful Bill Act, signed on July 4, 2025, made it permanent.⁸ The use-of-funds test is now the standing rule.

How Much Debt Qualifies

For homes acquired after December 15, 2017, you can deduct interest on up to $750,000 of combined mortgage and HELOC debt ($375,000 if married filing separately). Debt taken on before that date is grandfathered at the old $1 million limit ($500,000 if married filing separately).⁷ Those caps apply to the total across your main home and second home. Interest on debt above the cap is nondeductible.

Documenting What You Spent It On

Your lender reports the year’s interest on Form 1098, but that form says nothing about how you used the money.⁹ You have to figure out which portion of the interest qualifies and claim it on Schedule A when you itemize.¹⁰

The IRS allocates interest by what you actually did with the proceeds.¹¹ Deposit HELOC draws into the same checking account you use for groceries and car payments and tracing those dollars to a kitchen renovation gets hard fast. The cleaner approach: put HELOC funds in a separate account used only for the project, pay contractors and suppliers directly from it, and keep the invoices, receipts, and contracts. The burden of proof is on you.

Business Line of Credit Interest

Interest on a business line of credit is deductible as an ordinary cost of running the business, as long as the borrowed money actually went to business operations.¹² Payroll, inventory, equipment, rent during a slow month: all qualify. Use part of a business credit line for something personal and you have to split the interest, deducting only the business portion.¹³

The Section 163(j) Ceiling for Larger Businesses

Businesses with significant debt face a separate cap. The deduction for business interest expense can’t exceed your business interest income plus 30% of your adjusted taxable income for the year. Anything disallowed carries forward.¹⁴

Small businesses are exempt if their average annual gross receipts over the prior three years fall below an inflation-adjusted threshold. For 2025, the figure was $31 million.¹⁵ The IRS updates it annually. Most small businesses clear the test easily.

Personal Line of Credit Interest Isn’t Deductible

Interest on an unsecured personal line of credit used for personal spending gets no deduction. The statute is direct: personal interest is not deductible.¹⁶ Whether you used the funds for a vacation, a wedding, new furniture, or to pay down credit cards, the interest is a straight cost with no tax offset. That makes personal lines the most expensive category on an after-tax basis.

When LOC Funds Go Into Investments

There is one way an otherwise-personal borrowing produces a deduction: trace the money directly into investments that generate taxable income. Interest on debt used to buy stocks, bonds, or other investment property qualifies as investment interest expense.¹³

Your deduction can’t exceed your net investment income for the year. That generally means your investment earnings (interest, nonqualified dividends, short-term capital gains) minus investment expenses other than interest. Excess investment interest carries forward. You calculate and claim it on Form 4952.¹⁷

One limit worth knowing: you can’t deduct interest on money borrowed to buy tax-exempt investments like municipal bonds. The code won’t let you deduct on the borrowing side while collecting tax-free income on the other.

The Rule Underneath All of This: Interest Tracing

Across every category above, the deduction turns on what you did with the money, not on what kind of loan it was or what secured it. The IRS calls this interest tracing, and the rules require you to follow loan proceeds to specific expenditures.¹¹

Use one line of credit for multiple purposes and the interest splits accordingly. Draw $50,000 from a HELOC, spend $30,000 on a new roof and $20,000 on a vacation, and only 60% of the interest is potentially deductible. The same math governs a business credit line partly used for personal purchases. Keep separate accounts when you can and keep records either way. Proving how you used the money is always your job.

1
Office of the Law Revision Counsel. 26 U.S. Code 61 – Gross Income Defined
2
Internal Revenue Service. Topic No. 431, Canceled Debt – Is It Taxable or Not?
3
Internal Revenue Service. About Form 1099-C, Cancellation of Debt
4
Office of the Law Revision Counsel. 26 USC 108 – Income From Discharge of Indebtedness
5
Internal Revenue Service. Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments
6
Internal Revenue Service. About Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness
7
Internal Revenue Service. Publication 936 (2025), Home Mortgage Interest Deduction
8
Internal Revenue Service. One, Big, Beautiful Bill Provisions
9
Internal Revenue Service. About Form 1098, Mortgage Interest Statement
10
Internal Revenue Service. Real Estate (Taxes, Mortgage Interest, Points, Other Property Expenses)
11
eCFR. 26 CFR 1.163-8T – Allocation of Interest Expense Among Expenditures
12
Office of the Law Revision Counsel. 26 U.S. Code 162 – Trade or Business Expenses
13
Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses
14
Office of the Law Revision Counsel. 26 USC 163 – Interest
15
Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
16
Office of the Law Revision Counsel. 26 U.S. Code 163 – Interest
17
Internal Revenue Service. About Form 4952, Investment Interest Expense Deduction