Function

• The Internal Revenue Service recognizes the interest that you pay on your home equity line of credit as an income tax deduction. In order to claim the deduction, you must use Schedule A and itemize your deductions. Your lender will send you a form 1099-R that will show you how much you paid in interest during the year and you have to report that amount on line 10.
  
  

Limits

• Interest on HELOC loans is only tax deductible to a point. If you use the money from the HELOC for home improvements, the interest on the first $1 million is deductible. If you are married but file a separate return, you can only deduct the interest on the first $500,000. Home improvements refer to things that substantially increase the value of your home. For example, adding on a garage to your home would count, but fixing a broken pipe in your kitchen would not. If you use the HELOC for anything besides home improvements, you can only deduct the interest on the first $100,000. If married filing separately, the limit is only $50,000.
  
  

Figuring Your Deduction

• If the balance of your home equity line of credit exceeds the amount of your income tax deduction limit, you will have to figure the amount of your interest that you can deduct. To do so, divide your balance limit by your average balance for the year. Then multiply the result by your interest paid to determine how much you can deduct. For example, if you had a home equity line of credit balance of $400,000 and your limit is $100,000, you would divide $100,000 by $400,000 to get 0.25. If you paid $20,000 in interest, you would multiply 0.25 by $20,000 to find you could deduct $5,000.
  
  

Misconceptions

• If you take out a loan that is not secured by your home, you cannot deduct any of the interest even if you use it for home improvements. Similarly, if you pay for home improvements out of pocket, you cannot claim a deduction for the cost of those improvements. Only the interest on your home equity line of credit is eligible for a deduction.