Is interest from home equity loan to purchase of a car deductible?

Is interest from home equity loan to purchase of a car deductible?

The Answer : Yes , as long as the home equity loan is under $100,000 Home equity loan interest is deductible -- to a point By Michael D. Larson • Bankrate.com It pays to read the small print -- especially when it reads: "Consult your tax adviser." Those words accompany almost every home equity loan or line of credit solicitation for good reason. Tax regulations allow many people to deduct all or part of the interest they pay on these loans, but there are exceptions.

Because of these potential pitfalls, experts say people should educate themselves before borrowing against their homes. "If you have the option to take a home equity loan vs. going out and borrowing money at a higher rate which is not deductible and buying a car, then of course the home equity loan is going to be better," says Sandra Raiter, a tax analyst with the tax preparation firm Jackson Hewitt Inc. in Virginia Beach, Va. At the same time, Raiter says,

"People would get home equity loans -- you see the ads with the football star saying, 'Get a home equity loan and pay off your credit card bills' ... and then continue to charge on their credit cards. "It's not something to be done lightly." Making a move Thanks to changes in the tax laws dating back to 1986, many people can benefit by moving debt with non-deductible interest -- such as auto and motorcycle loans and credit cards -- over to a tax-deductible loan or line of credit secured by a home. The tax advantage has the effect of lowering the already low equity loan rate even further, making credit cards look like a pretty silly way to manage debt.

"For home equity, you can deduct the interest on a loan up to $100,000 regardless of where you use the money," says Thomas Langdon, a certified financial planner and tax professor at The American College in Bryn Mawr, Pa. "Let's say your children are going to college and you need extra cash. You can take a home equity loan of up to $100,000 and deduct the interest payments on the Schedule A." The limit applies regardless of whether a borrower has one $100,000 equity loan against a primary residence, or a combination of loans worth that much but secured against two different homes. Tax restrictions Tighter tax restrictions apply to borrowers who take out home equity loans that, along with a first mortgage, raise the debt to a level above the value of the property. In such circumstances,

borrowers can deduct the interest on only part of home equity debt. The Internal Revenue Service determines the eligible debt by subtracting the amount borrowed to acquire the property -- the first mortgage -- from the fair market value of the home. A homeowner with a $100,000 property and an $80,000 first mortgage, for example, might be able to get an equity loan for $45,000 under a 125 percent loan-to-value program.

But the house is worth only $20,000 more than the original debt, so only the interest on the first $20,000 of the home equity debt is deductible, according to Ron Kotick, a tax specialist with tax preparer H&R Block Premium in West Palm Beach, Fla. Improved circumstances Langdon notes that equity loans used for home improvement qualify for different treatment, however. They resemble first mortgages for tax purposes. And since people can deduct interest on $1 million worth of first mortgage debt, they have greater leeway than those who use their equity loans for things besides a new deck or garage. "It's called 'acquisition indebtedness' -- a loan you get to build your house, a loan to buy your house, or any loan you take out to substantially improve your home," says Roxanna Pletchan, a certified financial planner with Lassus Wherley & Associates in New Providence, N.J. For instance, someone with a $400,000 first mortgage who added a bedroom wing for $200,000 could deduct all the interest paid. A similar borrower who used the $200,000 loan for college expenses, on the other hand, only could deduct the interest paid on the first $100,000 of the balance.