Which projects qualify for home equity loan tax deductions?

Looking to access some cash to fund a home improvement project, pay down debt or accomplish another goal? If you own a home with sufficient home equity, you may be able to tap it for the money you need. 

Two of the most common options to borrow against your home's value are through a home equity loan or home equity line of credit (HELOC). These lending options can benefit you in distinctly different ways. For example, home equity loans give you a lump sum with fixed payments, while HELOCs let you borrow from a line of credit as necessary (up to the HELOC limit), which can give you more flexibility in terms of borrowing for ongoing projects.

Tax benefits are another potential plus these home equity options offer. In general, you may be able to deduct interest payments on home equity loans and HELOCs if the funds were used on eligible home improvements or upgrades. Not all home expenses qualify for the tax deduction, though. Here's what you need to know about what projects qualify for home equity loan tax deductions, and which don't.

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Home projects that qualify for home equity loan tax deductions

The IRS allows you to deduct your interest payments on home equity loans and HELOCs "if the borrowed funds are used to buy, build, or substantially improve the taxpayer's home that secures the loan." The loan must be secured by your primary or second home and adhere to specific eligibility criteria as well.

Here are some popular home improvements that may qualify for the deduction.

Kitchen renovations and bathroom remodels

Upgrading your kitchen or bathroom is one of the most effective ways to add value to your home. There's a common saying in real estate: "Kitchens and bathrooms sell homes." These areas are functional and contribute to your home's appeal, so buyers often prioritize them when evaluating a property. 

"Kitchen and bathroom remodels are the most common projects I have seen, and typically the most bang-for-your-buck in terms of home value appreciation," says Andrew Herzog, a certified financial planner at The Watchman Group.

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New rooms or floors

Your home's square footage is a significant factor in determining its value, so increasing its size with a new office, bedroom or even a new floor could boost your home's value. According to home services platform Angi, adding a second story adds up to 65% return on investment (ROI), depending on various factors. Herzog notes that adding extra space to a critical area of the home, such as a kitchen or bathroom, can qualify as a substantial improvement.

Installing solar panels

If you use your home equity loan or HELOC funds to add solar panels to your home, the interest may be tax deductible if it increases your home's value. 

Roof replacements

You might consider a home equity loan to put a new roof on your house. Not only will a new roof protect against leaks and enhance your home's curb appeal, but it may also qualify as a "substantial improvement" by increasing your home's value. According to Remodeling Magazine's 2024 Cost vs. Value Report, this type of improvement can deliver up to nearly 57% return on investment.

Basement or attic conversions

Improvements that help your home adapt to new uses may qualify for the home equity loan tax deductions. A home equity loan could give you the funds to transform a basement or attic into a family room, bedroom or office. Angi estimates basement remodels may recoup up to 70% of their costs.

Home projects that do not qualify for home equity loan tax deductions

Not all interest from home-related expenses is tax deductible. Generally, home improvements are eligible for the deduction, but repairs are not. But how can you distinguish between the two and know what is or isn't deductible? 

"A good general guideline to distinguish between home improvement and home repair is an improvement adds lasting material value, such as a new roof vs. installing a new toilet," says Kristine Stevenson Seale, an IRS enrolled agent and tax resolution specialist. "A repair keeps the house in good working order. There's no deduction for repairs. Improvements increase the value, or basis, of the home."

The bottom line

Rates on home equity loans and HELOCs currently average around 8.50%, and rates on this type of borrowing are almost always lower than personal loans and credit cards. Still, remember that these loan options are secured by your home, so only borrow what you can comfortably afford to repay, as missed payments could lead to foreclosure.

Check with your accountant or tax professional to confirm whether any home equity loan funds you use are tax deductible, and be sure to keep receipts.

"Maintaining records and appropriate documentation is always important when it comes to tax reporting, but even more so when it comes to home improvement costs," James Guarino, a CPA and managing director at Baker Newman Noyes, says. "Any improvement-related expense receipts should be maintained to substantiate costs incurred for a home addition or a home improvement or renovation."