How Does a HELOC Affect Your Taxes: Interest, Caps, Forgiven Debt

A home equity line of credit affects your taxes in three ways: the money you draw is not taxable income, the interest you pay may be deductible if you used the funds to improve the home securing the loan, and any balance your lender later forgives can be counted as income. So how does a HELOC affect your taxes in practice? Mostly through the interest deduction, which is narrow, capped, and only useful if you itemize. The rules below took their current shape in the 2017 Tax Cuts and Jobs Act, were made permanent in 2025, and apply fully for the 2026 tax year.

HELOC Draws Are Not Income

Borrowed money is not income to the IRS because you owe it back. Funds you draw from a HELOC are debt proceeds, so you don’t report them on your tax return no matter how much you draw or what you spend it on. Repaying the principal is not deductible either. Only the interest portion of your payments can qualify for a deduction, and only when specific conditions are met.

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 HELOC must be secured by your main home or a second home. A line of credit against an investment property follows different rules.

Spend the money on credit card balances, tuition, a car, or a vacation and the interest on that portion is not deductible. If you split a draw between a kitchen remodel and a vacation, you have to split the interest too: calculate the percentage of the outstanding balance that went to the qualified improvement, and deduct only that share.

What Counts as a Substantial Improvement

A substantial improvement is work that adds value to the 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, 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. One nuance helps: if painting is part of a larger renovation that itself qualifies, 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.

The $750,000 Combined Debt Cap

Even when every HELOC dollar goes to home improvements, the deduction is capped. Your primary mortgage balance and qualifying HELOC balance are added together, and interest is deductible only on the first $750,000 of combined debt. For married taxpayers filing separately, the cap is $375,000.³

Here is 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. The deductible portion is $750,000 divided by $800,000, or 93.75%. Only 93.75% of your total qualified interest across both loans is deductible. The interest on the remaining $50,000 gets no tax benefit.¹

Homeowners whose original mortgage was taken out on or before December 15, 2017, have a grandfathered limit of $1,000,000 ($500,000 if married filing separately). A HELOC opened later against that same home still counts toward the applicable limit.³

You Have to Itemize for the Deduction to Matter

HELOC interest, like mortgage interest, is an itemized deduction on Schedule A. If you take the standard deduction, you cannot claim it. 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.⁴

This is where the deduction quietly disappears for many homeowners. Itemizing only pays off when your combined deductible expenses — mortgage interest, HELOC interest, state and local taxes capped at $10,000, charitable contributions, and medical expenses above the threshold — 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, barely clearing the $32,200 standard deduction. Their actual benefit from the HELOC interest is only the margin above $32,200, not the full $6,000. Before tracking draws for tax purposes, run the numbers. If your primary mortgage interest and other deductions already clear the standard deduction comfortably, the HELOC interest adds real value. If you’re near the line, the recordkeeping may outweigh the payoff.

Records You Need to Defend the Deduction

The IRS doesn’t know what you spent 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 every dollar went to a qualifying improvement is on you.

The biggest mistake is depositing draws into a general checking account you also use for groceries and bills. Once funds are commingled, tracing them to specific improvement expenses becomes hard to win. A separate account used only for HELOC draws and improvement payments creates a clean trail. Keep HELOC statements showing each draw, contractor contracts and invoices, cancelled checks or payment records, and any building permits and plans. Match each draw to a corresponding expenditure by date. A $25,000 draw on March 10 paid to a roofer on March 14 tells an obvious story. Gaps and unmatched draws invite questions.

The 90-Day Safe Harbor

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

Forgiven HELOC Debt Can Be Taxed as Income

The other way a HELOC hits your taxes is in default. If a 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.⁶ The lender reports the forgiven amount on Form 1099-C, and you report it on your return for the year the cancellation occurs.

A few exceptions 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 up to the amount of your insolvency. Debt discharged in Title 11 bankruptcy is also excluded. A federal exclusion for canceled “qualified principal residence indebtedness” was available through the end of 2025, but it applied only to debt used to acquire the home, not home equity debt used for improvements or other purposes.⁶ If a settlement is on the table, talk to a tax professional before signing.

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. Real Estate (Taxes, Mortgage Interest, Points, Other Property Expenses)
4
Internal Revenue Service. Revenue Procedure 2025-32
5
Internal Revenue Service. About Form 1098, Mortgage Interest Statement
6
Internal Revenue Service. Topic No. 431, Canceled Debt – Is It Taxable or Not?