Home Equity Debt

• The interest on a home equity loan may be deductible if you provide the lender a security interest in a qualified home. Financing you obtain to purchase, build or substantially improve a home does not qualify as home equity debt unless the loan amount exceeds the principal balance of a first mortgage you use for those purposes. For tax purposes, home equity debt only refers to a loan you obtain after October 13, 1987.
  
  

Qualified Home

• Interest is eligible for a deduction if you take the loan out on a qualified home. Qualified homes include the main home you use as a principal residence plus any additional home you choose. If you take the equity loan on a second home that you rent out for part of the year, the IRS requires that you use it for personal purposes the longer of 15 days, or more than 10 percent of the days tenants occupy the home during the tax year. If you do not meet this requirement, you must treat the second home as rental property, which is not eligible for the home equity interest deduction. However, you may be able to deduct it as investment interest to the extent the home generates net investment income. You calculate net investment income by subtracting all allowable expenses other than interest from the gross rental revenue.
  
  

Security

• To qualify for the home equity interest deduction, the loan must be secured by the qualified home. Security requires that you pledge the home as collateral for the repayment of the loan. The loan agreement must state that in the event you default on loan payments, the lender has the authority to use the home to satisfy the debt.
  
  

Debt Limit

• The aggregate total of home equity debt that is eligible for the interest deduction is the smaller of $100,000 or the equity you have in the qualified home. You can determine the equity you have in the home by subtracting the outstanding principal balance you have on a first mortgage from the fair market value of the home. You must use the most recent fair market value at the time you prepare the tax return. You can assess the value by inquiring into the price for which other comparable homes in the area recently sold.