There is no single tax called “home equity tax.” The phrase is shorthand for the federal and local tax rules that can apply when you borrow against your home, sell it, inherit it, or watch its assessed value rise. Depending on which of those things you do, you could owe nothing at all, qualify for a deduction, or face capital gains tax and an additional investment surtax on your profit. The One Big Beautiful Bill Act made the 2017 tax-law restrictions permanent, so several rules that homeowners assumed were temporary now apply indefinitely in 2026.
Borrowing Against Your Equity Is Not Taxed
If you take out a home equity loan or open a HELOC, the money is not taxable income. The IRS treats it as debt, not earnings. You have to pay the lender back with interest, so no net wealth enters your pocket and nothing gets added to your gross income. This holds whether you take a fixed lump sum or draw from a revolving line over time.
That distinction matters. Selling stock or cashing out a retirement account for the same amount would create a taxable event and could push you into a higher federal bracket, where rates run from 10% to 37%.1Internal Revenue Service. Federal Income Tax Rates and Brackets Home equity borrowing does not, as long as the loan stays outstanding and in good standing.
Capital Gains Tax When You Sell
Selling is where equity meets the tax collector. Your profit — sale price minus your adjusted cost basis — is a capital gain. Most homeowners pay nothing on it, because the IRS allows a large exclusion: up to $250,000 of gain for single filers and up to $500,000 for married couples filing jointly.2Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence
Ownership and Use Tests
To claim the full exclusion, you have to pass two tests. You must have owned the home for at least two of the five years before the sale, and you must have lived in it as your primary residence for at least two of those same five years.2Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence The two years don’t have to be consecutive. Twenty-four months scattered across the five-year window will do.
Sell earlier and you may still qualify for a partial exclusion. A job relocation that moves your workplace at least 50 miles farther from the home, a health-related move recommended by a doctor, or unforeseeable events like divorce, job loss, or the home being destroyed can all trigger partial relief.3Internal Revenue Service. Publication 523, Selling Your Home The partial amount is prorated based on how much of the two-year requirement you actually met.
Rates on Gains Above the Exclusion
If your profit tops $250,000 (or $500,000 for joint filers), the excess is taxed as a long-term capital gain. For 2026, those rates are 0%, 15%, or 20% depending on your taxable income.4Internal Revenue Service. Topic No. 409, Capital Gains and Losses Most sellers with a taxable gain land in the 15% bracket. The 0% rate applies only at lower income levels, and the 20% rate does not kick in until single-filer taxable income exceeds roughly $545,000.
The closing agent typically files a Form 1099-S reporting the proceeds to the IRS, so the agency already knows about the sale.5Internal Revenue Service. About Form 1099-S, Proceeds From Real Estate Transactions If you owe tax on the gain, you report it on Form 8949 and Schedule D.6Internal Revenue Service. Instructions for Form 8949
Shrinking the Taxable Gain With Basis Adjustments
Your cost basis is not just what you paid for the house. Every qualifying improvement over the years increases that basis, which shrinks the taxable gain when you sell. This is where old renovation receipts pay off.
The IRS allows you to add the cost of improvements like these to your basis:
- Additions such as bedrooms, bathrooms, garages, decks, and porches
- Systems such as heating, central air, security, wiring upgrades, and water filtration
- Exterior work such as a new roof, siding, storm windows, or a satellite dish
- Lawn and grounds work including landscaping, driveways, fences, retaining walls, and swimming pools
- Interior work such as a kitchen remodel, new flooring, built-in appliances, and fireplaces
- Insulation and plumbing including attic insulation, water heaters, septic systems, and soft water systems
Routine maintenance and repairs that merely keep the home in its current condition — painting, patching drywall, fixing leaks — do not count unless they were part of a larger improvement project.3Internal Revenue Service. Publication 523, Selling Your Home You also cannot include the cost of an improvement that is no longer part of the home, like carpet you installed and later ripped out.
A quick example. You bought for $300,000, spent $80,000 on a kitchen remodel and a new roof, and sold for $650,000. Your adjusted basis is $380,000, making the gain $270,000. A single filer excludes $250,000 and pays capital gains tax on only $20,000. Without the basis adjustments, the taxable portion would have been $100,000.
The 3.8% Net Investment Income Tax
Higher-income sellers face an added layer. The 3.8% net investment income tax applies when your modified adjusted gross income exceeds $200,000 for single filers, $250,000 for joint filers, or $125,000 for married filing separately.7Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax Those thresholds are not adjusted for inflation, so more taxpayers cross them each year.
The portion of your gain excluded under the $250,000 or $500,000 rule is not subject to this tax. Only the taxable gain — profit above the exclusion — counts as net investment income. A married couple with a $600,000 gain would exclude $500,000 and could owe the 3.8% surtax on the remaining $100,000, if their overall income is high enough to trigger it. The tax is calculated on the lesser of your net investment income or the amount your income exceeds the threshold, so it is not always the full 3.8% on the entire gain.
Inheriting a Home and the Stepped-Up Basis
If you inherit a home, the built-up equity gets a very different tax treatment. Instead of taking on the original owner’s cost basis, you receive a “stepped-up” basis equal to the home’s fair market value on the date of the previous owner’s death.8Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent All the appreciation that happened during their lifetime is effectively wiped off the tax books.
If a parent bought a home for $120,000 in 1990 and it was worth $550,000 when they passed away, your basis is $550,000, not $120,000. Sell promptly at that value and the taxable gain is close to zero. For 2026, the federal estate tax exemption is approximately $15 million per person, and the stepped-up basis applies independently of that threshold.
When Home Equity Debt Is Forgiven
If a lender forgives or cancels part of your home equity debt through a short sale, foreclosure, loan modification, or settlement, the IRS generally treats the forgiven amount as taxable income.9Internal Revenue Service. Home Foreclosure and Debt Cancellation You received money you no longer have to pay back, so it functions like income. The lender reports the forgiven amount on a Form 1099-C, and you must include it on your return.
For years, a special exclusion protected homeowners from this tax on a primary residence, allowing up to $2 million in forgiven mortgage debt to be excluded from income. The statutory provision for qualified principal residence indebtedness expired for discharges occurring after December 31, 2025, unless the arrangement was entered into in writing before that date.10Office of the Law Revision Counsel. 26 USC 108 – Income From Discharge of Indebtedness Homeowners whose debt is forgiven in 2026 or later generally cannot rely on this exclusion.
Two exceptions still apply regardless of timing. If you are insolvent at the time of the cancellation, meaning your total debts exceed the fair market value of everything you own, you can exclude the forgiven amount up to the extent of your insolvency. Debts discharged in a formal bankruptcy proceeding are never taxable.9Internal Revenue Service. Home Foreclosure and Debt Cancellation Proving insolvency requires a detailed asset-and-liability snapshot, so working with a tax professional before filing is worth the cost.
Property Taxes and the SALT Cap
Local governments tax the assessed value of your home every year, and as that value rises, your property tax bill tends to follow. This is the most visible ongoing tax tied to home equity. The local assessor sets the value, the jurisdiction sets the rate, and the two combine to produce your annual bill. In neighborhoods where prices climb quickly, a reassessment can add hundreds of dollars in a single year.
For federal tax purposes, property taxes are deductible as an itemized deduction, but only within the state and local tax (SALT) deduction cap, which the One Big Beautiful Bill Act kept in place. For 2026, that cap limits the combined deduction for property taxes, state income taxes, and local taxes. If you live in a high-tax area, you may hit the cap well before covering all your property taxes, which means part of that expense produces no federal benefit. You only gain from itemizing property taxes at all if your total itemized deductions exceed the standard deduction.
When Home Equity Borrowing Produces a Tax Benefit
Borrowing against equity is not taxed, but the interest you pay may be deductible in narrow circumstances. Since 2018, and now permanently under the One Big Beautiful Bill Act, interest on a home equity loan or HELOC is deductible only if you use the money to buy, build, or substantially improve the home that secures the loan.11Office of the Law Revision Counsel. 26 USC 163 – Interest Spend the proceeds on credit card payoff, tuition, a vacation, or anything else, and none of the interest qualifies.
There is also a dollar ceiling. Your total mortgage debt across your primary home and one second home cannot exceed $750,000 for the interest to be fully deductible, or $375,000 for married filing separately.11Office of the Law Revision Counsel. 26 USC 163 – Interest That cap includes your original purchase mortgage plus any home equity borrowing on top. If the combined balance exceeds the limit, you can only deduct a proportional share of the interest.
The IRS also draws a firm line between substantial improvements and routine maintenance. Adding a bathroom, replacing a roof, installing central air, or building a deck qualifies. Painting, patching drywall, fixing a leaky faucet, or replacing broken hardware does not.3Internal Revenue Service. Publication 523, Selling Your Home Small repairs completed as part of a larger renovation can ride along with the improvement. Keep invoices that tie loan draws to the project, because in an audit the burden is on you to prove where the money went.