When tax season arrives, many homeowners assume that interest paid on any mortgage secured by their home is automatically deductible. It's not that simple. The IRS draws a critical line between *acquisition debt* and *home-equity debt*, and only acquisition debt qualifies for the mortgage-interest deduction—subject to a cap.
What counts as acquisition debt
Acquisition debt is money borrowed to buy, build, or substantially improve your primary residence or a second home. If you took out a mortgage to purchase your house, that's acquisition debt. If you later took a home-equity line of credit and used the proceeds to add a second story or remodel the kitchen, that HELOC also qualifies as acquisition debt because the funds improved the secured property.
The key is *use of proceeds*. The IRS doesn't care what the loan is called—first mortgage, second mortgage, HELOC, or cash-out refinance. It cares what you did with the money.
What does not count
If you open a HELOC or second mortgage and use the cash to pay off credit cards, buy a car, fund a wedding, or cover college tuition, that's home-equity debt under IRS rules. The interest on home-equity debt is not deductible, even though the loan is secured by your home.
This surprises borrowers who remember the old rules. Before 2018, you could deduct interest on up to $100,000 of home-equity debt regardless of use. That provision was suspended by the Tax Cuts and Jobs Act and remains suspended through 2025.
The combined cap
Even when your debt qualifies as acquisition debt, there's a limit. For loans originated after December 15, 2017, you may deduct interest on up to $750,000 of combined acquisition debt ($375,000 if married filing separately). That cap applies to the total of all qualifying mortgages on your primary and second homes together.
If you have a $600,000 first mortgage and a $200,000 second mortgage—both used for acquisition purposes—you can only deduct interest on the first $750,000. The interest attributable to the remaining $50,000 is not deductible. Loans originated on or before December 15, 2017, are grandfathered under the old $1,000,000 limit, but any refinance or new money after that date falls under the new cap.
Documentation and record-keeping
The burden of proof is on you. Keep closing statements, disbursement records, contractor invoices, and receipts that show how loan proceeds were spent. If audited, the IRS will ask for evidence that the money went toward acquisition or improvement, not personal expenses.
The Alliance take
Understanding the acquisition-debt rule helps you plan ahead. If you're considering a cash-out refinance or HELOC, think about whether you'll use the funds in a way that preserves the deduction. If the answer is no, factor the lost tax benefit into your cost analysis. Consult a CPA or attorney; this is not tax or legal advice.
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