Q: I was laid off and have had a difficult time finding a suitable job. We have lived on my part-time work and my wife’s job as a teacher. I started investigating starting my own business, and I think I have a good opportunity and a plan to succeed. My problem is raising capital. My wife and I own a home that is worth about $370,000 and it has a first mortgage of $140,000. I have avoided borrowing against my equity because I might have to use it for college costs, but I am pretty confident that I can make this business opportunity work if I can get financing. I need to borrow about $125,000 on a home equity loan. That gives me the best interest rate. My question is whether I can deduct this interest on my taxes.
A: Yes you can, because the loan proceeds will be used to fund your business. Interest expense is “traced” to the use of the loan proceeds. Money used for business purposes is allowed as business interest.
You will need to do one thing to be able to deduct all of the interest. The tax law has a special rule that treats any debt secured by a residence as “qualified residence interest.”
The interest on qualified residence debt is deductible if the loan is used to acquire, construct, or improve your residence. If the proceeds are used for some other purpose, then the interest on up to $100,000 of loan proceeds is still deductible as “home equity debt.”