Home Equity and Taxes

Tax treatment is one of the most misunderstood parts of home equity, and getting it wrong can be expensive. The general principles below are a starting point — not advice — and your own situation should be confirmed with a tax professional.

Borrowing is generally not taxable

Money you borrow against your home — through a cash-out refinance, home equity loan, or HELOC — is generally not taxable income, because a loan is not income. You are receiving your own equity as debt, and debt is repaid, not earned.

Interest deductibility is conditional

Whether the interest on home equity debt is deductible depends on how the money is used and on prevailing tax rules. Broadly, interest can be deductible when the borrowed funds are used to buy, build, or substantially improve the home that secures the loan, subject to limits. Interest on funds used for other purposes is typically not deductible. Rules change, so verify the current treatment before relying on a deduction.

Selling: the capital-gains question

A sale is where tax most often arises. If the home has appreciated, the gain — sale price minus your cost basis — may be subject to capital-gains tax. Many homeowners selling a primary residence qualify for an exclusion of a substantial portion of that gain, provided they meet ownership and use tests. Second homes and investment properties generally do not qualify for the same exclusion.

Cost basis matters

Your taxable gain is reduced by your cost basis, which includes the original purchase price plus qualifying improvements over the years. Keeping records of capital improvements can meaningfully lower a future tax bill, which is why it is worth retaining receipts long before you ever plan to sell.

Tax outcomes depend on your filing status, how long you have owned and lived in the home, and current law. Treat this guide as orientation, and confirm specifics with a qualified tax adviser.