Taking out a home equity line of credit (HELOC) for home remodeling comes with a whole slew of perks — you withdraw money when you need it — it's as easy as writing a check off your line. And, you initially only need to pay interest on the amount you've borrowed each month. "You will not be paying interest until you actually make a withdrawal on the line," said Jon Giles, senior vice president of TD Bank's Home Equity Group. "It's flexible, so you can use as much or as little as you like."
HELOCs excel at long-term, bit-by-bit projects like home remodeling, but their benefits don't end at your bathroom remodel. When April rolls around, you might just find yourself with some tax benefits, too — both from the HELOC itself and from the home improvement work your HELOC has funded.
According to a survey conducted by TD Bank, 46 percent of people choose HELOCs because of their low interest rates — usually anywhere between 3.5% - 4.25% APR during an intro period. And to make it an even sweeter deal, the interest you pay on your HELOC is typically tax deductible, just like it is on your mortgage. Unless you also claim the Alternative Minimum Tax, your HELOC is deductible up to a $100,000 (though you can't deduct more than your home's fair market value).
Because of how closely the tax considerations of a HELOC resemble that of a mortgage, many homeowners even use a HELOC to purchase their home in order to avoid paying hundreds of dollars a month in private mortgage insurance. By purchasing your home with the popular "80-10-10" method — 80 percent first mortgage, 10 percent HELOC, and 10 percent down payment — you can dramatically reduce your down payment amount and ditch the PMI payment entirely. When you use the HELOC to purchase your home, the interest is fully deductible.
Eco-Friendly = Tax Friendly
Not only is the interest on your HELOC tax deductible when you make home improvements, but those improvements can snag you some helpful tax credits. As of the 2016 tax year, filing Form 5695 with your tax return can net you some pretty major benefits.
Most prominently, the Residential Energy Efficiency Property Tax Credit offers 30 percent of the material cost and installation of renewable energy sources back, including things like solar panels, solar-powered water heaters, geothermal heat pumps, wind turbines and hydrogen fuel cells. Some of these perks will expire, but the credit for solar home improvements is good through at least 2019.
Medical Home Improvements
Even when paying for them with a HELOC, permanent home improvements aren't usually tax deductible, but there are a handful of exceptions to that rule. Case in point: Home improvements made for the main purpose of medical care.
If you itemize your deductions and the cost of medical home improvements exceeds 10 percent of your adjusted gross income (or 7.5 percent for homeowners over the age of 65), you can deduct the expenses of HELOC-funded projects. These include entrance and exit ramps, widened entryways, railings and support bars, accessible cabinets or fixtures, lifts, stairway modifications and warning systems like fire alarms and smoke detectors, among other projects.
Kitchen remodels and bathroom upgrades may be some of the most popular ways to use your HELOC, but don't forget about the home office. If you qualify for the home office deduction when filing your taxes — meaning you have a business and use a portion of your home as an office for that business — you're able to deduct 100 percent of the cost of improvements made to your home office space. Built-in shelves surrounding your desk? Deductible. New hardwood floors for the office? Also deductible. You get the idea.
Likewise, this deduction partially applies to home-wide benefits. For example, if you installed new flooring throughout your house and your home office occupies 10 percent of that space, you can depreciate 10 percent of the cost of your flooring upgrade.
See More: 50 Tax Write-Offs You Don't Know About
Deductible Rental Space
Adding new additions to your house doesn't net you a big return on investment — something to consider if you're like the 41 percent of people whose property value has remained stagnant over the last 12-18 months. But if your HELOC has gone toward a new bedroom or in-law house to rent out, you could offset the costs via tax deductions.
This tax perk works similarly to the home office deduction, in that you depreciate the expense of home improvements as a rental expense. If your HELOC-funded remodel goes right to rented space, you can deduct that expense in full; if the project affects the whole house including the rented space, you depreciate the cost of improvements based on the percentage of your home you rent out.
Just be sure you speak to a tax adviser beforehand to ensure you're covered. "Make sure you qualify for a real estate interest tax deduction and it is included in your tax return," advises Giles.
Saving on the Sale
About 64 percent of those who use a HELOC do so for home-related expenses, according to TD Bank. Though we don't know exactly how many of them use a HELOC to make home improvements before a sale, it's certainly a popular strategy — especially considering that projects like new insulation, trendy siding and premium exterior doors can generate returns on investment ranging from 91 percent to nearly 117 percent, immediately adding significant value to your home.
Sidney Torres, host of CNBC's "The Deed" advises homeowners to "find out the value of your home before and after making improvements" in order to avoid over-investing and assess the value of your upgrades.
Speaking of value, that's where deducting home improvements on your tax return comes in. Though only certain kinds of projects can be deducted when you own your home — like the aforementioned home office, solar, rental and medical improvements — you can deduct home improvements that add material value to the property, prolong its life, or adapt it to new uses when you sell your home. This is because these types of changes are included in your home's adjusted cost basis; the higher that number, the lower your capital gain — and lower capital gain means you pay less taxes when your home sale profit exceeds $250,000.