Do I Have to Pay Taxes on a Home Equity Loan?

Money you receive from a home equity loan is not taxable income. You borrowed it and you owe it back, so the IRS treats the proceeds the same as any other loan, regardless of what you spend them on. The real tax questions around taxes on a home equity loan are two: whether the interest you pay is deductible, and whether you owe tax if the lender later forgives part of what you owe.¹

The Loan Itself Is Not Income

When a lender deposits home equity loan or HELOC funds into your account, nothing about that disbursement is taxable. The same holds for a line of credit you draw against over time. It does not matter whether the loan is secured by your house, a car, or nothing at all, and it does not matter what you do with the money. A $100,000 HELOC spent entirely on a vacation produces zero taxable income from the borrowing itself.²

So no annual return entry is required just because you took out the loan. The tax picture only opens up around the interest you pay and, in rare cases, around debt the lender later writes off.

When the Interest Is Deductible

Interest on a home equity loan or HELOC is deductible only if the borrowed money went to buy, build, or substantially improve the home that secures the loan. This is a hard rule. If the money went anywhere else, the interest is personal interest, and personal interest is not deductible.³

Common uses that do not qualify include paying off credit cards, covering tuition or medical bills, buying a car, or investing. A $50,000 home equity loan used to consolidate credit card debt produces no interest deduction, even though the debt is secured by your home.¹

Many homeowners had been expecting a prior rule to return in 2026 that allowed deduction of interest on up to $100,000 of home equity debt regardless of how the funds were spent. That did not happen. The One Big Beautiful Bill Act, signed in July 2025, made permanent the 2017 Tax Cuts and Jobs Act rule that eliminated that deduction.⁴

What Counts as a Substantial Improvement

The IRS defines a substantial improvement as one that adds value to the home, extends its useful life, or adapts it to a new use. A kitchen remodel, a new roof, a room addition, and a full window replacement all qualify. Routine maintenance like repainting a room does not, unless the painting is part of a larger renovation project that qualifies on its own.¹

Keep the Paper Trail

The burden of proof falls on you. Keep receipts, contractor invoices, and records that trace the loan disbursement directly to the qualifying project. Without that documentation, the IRS can reclassify the interest as non-deductible personal interest. Most deduction challenges fall apart here: the homeowner did the renovation but cannot connect the loan proceeds to the specific expenditure.

The $750,000 Combined Debt Limit

Even when the money went to a qualifying use, the deduction is capped. You can deduct interest only on the first $750,000 of combined mortgage debt if you file jointly, or $375,000 if you file single or married filing separately. That ceiling covers everything secured by the home: your original mortgage, any home equity loan, and any HELOC balance.¹

Picture a couple with a $600,000 first mortgage who take out a $200,000 home equity loan to build a garage. Their combined debt is $800,000, which puts them $50,000 over the limit. They can deduct the interest attributable to $750,000 of that debt. The interest on the remaining $50,000 is not deductible, even though every dollar went to a qualifying improvement.

Older mortgages get a different ceiling. If you took out acquisition debt on or before December 15, 2017, the limit on that older debt is $1,000,000 ($500,000 if married filing separately). Any home equity debt taken out after that date still falls under the $750,000 cap, and the older debt reduces the room available under it.¹

If You Used the Loan for More Than One Thing

Split the proceeds between a home improvement and anything else and you have a mixed-use mortgage. Only the portion of the interest tied to the qualifying use is deductible, and you have to trace the dollars to allocate it.

Say you took a $100,000 HELOC, spent $60,000 on a bathroom addition, and spent $40,000 on a boat. Sixty percent of the interest is potentially deductible, subject to the $750,000 combined cap, and forty percent is not. Principal payments on a mixed-use mortgage are applied first to the non-qualifying portion, then to any grandfathered debt, and finally to acquisition debt.¹

One narrow exception: if the non-qualifying slice went to a business or investment use, that interest may be deductible under separate rules as a business or investment expense rather than as mortgage interest. Publication 936 points taxpayers in that situation to the interest allocation rules in the temporary regulations under Section 163.¹

The Standard Deduction Reality Check

Claiming home equity interest requires itemizing on Schedule A. Itemizing only helps if your total itemized deductions exceed the standard deduction. For 2026 the standard deduction is $32,200 for married couples filing jointly, $16,100 for single filers or married filing separately, and $24,150 for heads of household.⁵

For many homeowners with modest mortgage balances, the standard deduction is higher than everything they could itemize, which means a technically deductible home equity interest payment produces no actual tax benefit. Your lender will send Form 1098 by the end of January showing the interest you paid; it is still worth running the numbers both ways before assuming the deduction helps you.⁶

When Forgiven Debt Becomes Taxable Income

The one way a home equity loan can create taxable income is through cancellation. If a lender later forgives, cancels, or settles the debt for less than you owe, the forgiven amount is generally taxable. The lender will issue Form 1099-C reporting any canceled debt of $600 or more, and the IRS expects you to include that amount as ordinary income on your return.⁷

There are exceptions. If you were insolvent immediately before the cancellation, meaning your total liabilities exceeded the fair market value of all your assets, you can exclude the canceled amount from income up to the extent of your insolvency. Home equity loans count toward your total liabilities in that calculation. You claim the exclusion by filing Form 982 with your return.⁸

A separate exclusion for canceled qualified principal residence indebtedness applied through the end of 2025 but is not available for discharges on or after January 1, 2026, unless the discharge was subject to a written arrangement entered into before that date. For home equity debt forgiven in 2026 or later, the insolvency exclusion and the bankruptcy exclusion are the remaining paths to avoid taxation.²

1
Internal Revenue Service. Publication 936 (2025), Home Mortgage Interest Deduction
2
Internal Revenue Service. Topic No. 431, Canceled Debt – Is It Taxable or Not?
3
Internal Revenue Service. Real Estate (Taxes, Mortgage Interest, Points, Other Property Expenses)
4
Office of the Law Revision Counsel. 26 USC 163 – Interest
5
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
6
Internal Revenue Service. Instructions for Form 1098 (Rev. December 2026)
7
Internal Revenue Service. About Form 1099-C, Cancellation of Debt
8
Internal Revenue Service. Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments