Home equity is traditionally used for such familiar costs as home repair, education and debt consolidation, but wealthy clients have the option to use such assets to reduce taxes, advisors say.
Such strategies, however, carry a price for any tax savings.
“It depends on an individual’s tax bracket and their priorities, but there are several options for higher-net worth individuals,” said Steve Resch, vice president of retirement strategies at reverse mortgage company Finance of America Reverse. “One option is using home equity to fund a Roth IRA conversion, shielding wealth from higher rates in the future.”
One strategy focuses on using a home equity loan to pay the taxes generated by converting an IRA to a Roth IRA. Considerations for this strategy include comparing the mortgage interest rates and anticipated home appreciation against the projected growth of income-tax free Roth assets and whether the client expects to be in a higher tax bracket in the future, Resch said.
Looming in the background of such an analysis is the fact that certain provisions of the Tax Cuts and Jobs Act (TCJA) are set to expire at the end of next year without intervention by Congress.
Another tax-advantaged option for home equity: using the money for gifting before the TCJA sunsets at the end of next year and the estate tax exemption is halved to about $7 million.
“Gifts up to the annual exemption don’t require a gift tax return be filed,” Resch said. “High-net-worth individuals could transfer substantial assets to their choice of recipients now with the higher estate tax exemption limits.”
A wealthy client could use a home equity loan or reverse mortgage and gift the proceeds with no tax liability unless the gift exceeded the current exemption limit, Resch added.
But should advisors recommend those options?
“Interest rates are still relatively high, and I’d caution someone using a loan to fund the tax balance due on a Roth conversion,” said Marci Spivey, CPA and partner of tax services at Cherry Bekaert Advisory in Atlanta. “They need to consider all the factors [and] need to have a plan to service and then repay this loan since they are using it to fund a retirement plan, where the cash from that plan may not be available to repay a loan for many years.”
Home equity loans are not subject to income tax, for instance, but they do incur interest.
Home equity lines of credit can generally only be used to substantially improve a home if the borrower wants to deduct the interest as home mortgage interest, “up to a total of $750,000 in total mortgage principal including primary mortgage, lines of credit, first and second home and so on,” Spivey said. “Also, you cannot deduct mortgage interest that exceeds the combined cost of your home.”
Beginning in 2026, the mortgage interest deduction will revert to pre-TCJA levels in 2026, allowing interest to be deducted on the first $1 million in home mortgage debt and $100,000 in a home equity loan.
Still, “leveraging home equity ... to lower your taxes is not a strategy we’d recommend, especially for a wealthy client and definitely for the ultra-high-net-worth client,” said Todd Neal, client management partner at Callan Family Office in West Palm Beach, Fla. “If you aren’t able to itemize your deductions instead of taking the standard deduction, there may not be any tax savings.”
Interest can still be deductible, but only for certain criteria, such as for some kinds of home improvement and in special circumstances. But “it doesn’t make sense to take out a loan or HELOC just for the deduction,” Neal said. “Rates are [also] much higher today than they have been for the last 10-plus years.
“With interest rates where they are, we are not recommending clients take on unnecessary debt,” Neal said. “Rather, we’re looking for ways to reduce debt and interest expense.”