Borrowing against your home equity can be a sound way to add extra cash to your coffers. By putting your house up as collateral, you can get a lower interest rate than you'd get with many other types of loans. And, one lesser-known benefit to borrowing against your home equity is that in some circumstances, you can deduct the interest payments you make on the loan from your tax return, saving you a bit of money. 

There are specific cases when this applies, though, so make sure you do your homework beforehand.

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How your 2023 home equity loan can be deducted from your taxes next year

Whether you're considering a traditional home equity loan or a home equity line of credit, chances are you'll be able to make some deductions from your taxable income when you file for taxes next year. Here's what you need to know.

The money has to be used for home improvements

Your interest payments are only deductible if the money is used to improve the home that the equity was borrowed against. This means that if you're taking the money out to fund your new small business, you likely can't deduct any interest payments from your tax return. On the other hand, if you're using the loan to build a new garage or renovate your kitchen, you'll get this tax benefit. 

"Interest on home equity loans and lines of credit are deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer's home that secures the loan," the IRS states online. "The loan must be secured by the taxpayer's main home or second home (qualified residence), and meet other requirements.

"Generally, you can deduct the home mortgage interest and points reported to you on Form 1098 on Schedule A (Form 1040), line 8a," the IRS states. "However, any interest showing in box 1 of Form 1098 from a home equity loan, or a line of credit or credit card loan secured by the property, is not deductible if the proceeds were not used to buy, build, or substantially improve a qualified home."

If you aren't sure if you qualify, consider talking to a tax expert or using an online tax filing service.

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The deadline is December 31

To claim this benefit on your 2023 tax return, which you'll file on or before April 14, 2024, you'll need to take out the loan before the end of this year. If you fail to meet this deadline, though, don't worry — you can claim this benefit on the following year's tax return.

Home equity loans and HELOCs have the same tax benefit

Both home equity loans and home equity lines of credit (HELOCs) allow you to money from the portion of your home that you own. The big difference is that with a home equity loan, you take out a lump sum, whereas with a HELOC, you can borrow money as you need it, like using a credit card. The other big difference is that most home equity loans have a fixed rate while most HELOCs have a variable rate.

When it comes to tax deductions, though, the two work the same way. With either one, you have the option to deduct interest payments on your tax return, provided the money is being used to improve the home you borrowed against.

The bottom line

If you want to take a home equity loan tax deduction on your 2023 tax return, you'll need to open the loan before the deadline. Remember, though, that you can deduct interest payments as long as the money is used to improve the home used to take out the loan. Otherwise, the benefit does not apply.