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Tax Aspects of Refinancing a Home Mortgage

by Amanda Domitrowich

Are you planning to refinance the mortgage on your home and wondering about the tax rules regarding the refinancing? This article will discuss whether you can deduct the interest you will pay on your new mortgage, the points that you pay, and other fees that you may pay in connection with the refinancing.

Interest deduction on refinanced mortgage. Interest on a refinanced mortgage will be deductible, within the limits discussed, if it falls into one of the following categories:

Your old mortgage was taken out after Dec. 15, 2017. Debt that results from the refinancing of debt that was incurred after Dec. 15, 2017 to buy, build, or substantially improve your main or second home, and that is secured by that home. But interest on this debt is deductible only to the extent that the amount of the debt from refinancing doesn’t exceed: (a) the amount of the original debt that has been refinanced, and (b) $750,000 ($375,000 for married taxpayers filing separately).

Your old mortgage was taken out after Oct. 13, 1987, but before Dec. 16, 2017. Debt that results from the refinancing of debt that was incurred after Oct. 13, 1987, but before Dec. 16, 2017, to buy, build, or substantially improve your main or second home, and that is secured by that home. But interest on this debt is deductible only to the extent that the amount of the debt from refinancing doesn’t exceed: (a) the amount of the original debt that has been refinanced, and (b) $1 million ($500,000 for married taxpayers filing separately). Note that for the $1 million ($500,000) limit to apply, the refinancing debt has to be incurred before the expiration of the term of the old debt.

Your old mortgage was taken out before Oct. 14, 1987. Debt that results from the refinancing of debt that was incurred before Oct. 14, 1987-no matter how the proceeds of the mortgage were used-and that is secured by your first or second home. All of the interest you pay on this debt is fully deductible, as long as the term of the old mortgage hasn’t expired, and the amount of the debt resulting from the refinance doesn’t exceed the amount of principal remaining on the old debt immediately before the refinancing.

Interest on refinanced “home equity loans” isn’t deductible, 2018 – 2025. “Home equity debt,” as specially defined for purposes of the mortgage interest deduction, means debt that: (1) is secured by the taxpayer’s home, and (2) wasn’t incurred to acquire, construct, or substantially improve the home). From 2018 through 2025, there’s no deduction for the interest on home equity debt, no matter when the home equity debt was incurred. And interest on debt resulting from the refinancing of such home equity debt isn’t deductible.

Beginning with 2026, home equity debt will be deductible, as will the debt resulting from a refinancing of home equity debt. However, the interest that can be deducted will be limited to loan amounts of the lesser of $100,000 ($50,000 if your filing status is married filing separately) or your equity in the home.

Points. In general, points that you pay to refinance your home aren’t fully deductible in the year that you paid them. Instead, you can deduct a portion of the points each year over the life of the loan.

To figure your deduction for points, divide the total points by the number of payments to be made over the life of the loan. Then, multiply this result by the number of payments you made in the tax year.

For example, if you paid $3,000 in points and you will make 360 payments on a 30-year mortgage, you can deduct $8.33 per monthly payment. For a year in which you make 12 payments, you can deduct a total of $99.96 ($8.33 × 12).

However, you may be entitled to a larger first-year deduction for points if you used part of the proceeds of the refinancing to improve your home and you meet certain other requirements. In that case, the points associated with the home improvements may be fully deductible in the year they were paid.

For example, say that you refinance a high-rate mortgage that has an outstanding balance of $80,000 with a new lower-rate loan for $100,000. You use the proceeds of the new mortgage loan to pay off the old loan and to pay for $20,000 of improvements to your home. Since 20% of the new loan was incurred to pay for improvements, 20% of the points you paid can be deducted in the year of the refinancing.

If you’re refinancing your mortgage for the second time, the portion of the points on the first refinanced mortgage that you haven’t yet deducted may be deductible at the time of the second refinancing.

Penalties and fees. A prepayment penalty that you pay to terminate your old mortgage is deductible as interest in the year of payment.

However, fees paid to obtain the new mortgage aren’t deductible, nor can you add them to your basis in your home to reduce the gain when you sell it. Examples of such nondeductible fees are credit report fees, loan origination fees, and appraisal fees.

Give us a call today to go over these rules with you in greater detail!

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