There are some special tax rules with regard to what costs can be deducted in connection with an equity loan or credit line. Let's see what tax breaks you'll get from Uncle Sam.

Interest

The beauty of home equity loans and lines of credit is that the interest, on debt up to $100,000, is tax-deductible no matter what you use the money for.

IMPORTANT NOTE: If you are married and filing separately, the limit is reduced to $50,000.

If you borrow against the equity in your home to make major capital improvements to the home, the interest on up to $1 million of debt (counting both your existing first mortgage and the home equity loan) is tax-deductible.

IMPORTANT NOTE: If you are married and filing separately, the limit is reduced to $500,000.

Points

There are three different ways that the IRS treats home equity points.

1. If you are borrowing to make capital improvements to your home, the points are fully deductible in the year you borrow. Now, this gets tricky if only a portion of the loan is used for the improvements. If this is the case, only the portion of the points related to the improvements is deductible in the year you borrow. The remaining points are required to be deducted equally each year over the term of the loan or the line of credit.
2. If you are borrowing for any other reason, the points must be deducted equally each year over the term of the loan or the line of credit.
3. If you pay off your loan early, the points become deductible immediately.