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Deducting Points On Mortgage Refinancing |
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The popularity of mortgage financing is at an all-time high with interest rates recently dipping to 40-year lows. For most, mortgage refinancing means straight forward tax consequences, where the interest on the new loan is deducted, like with the loan that was refinanced. But if paying points or the new loan being greater than the refinanced loan, it's important to be aware of certain tax rules. Points Paid Points, prepaid interest or loan origination fees are fully deductible, provided the loan applied for is for the original purchase of a personal residence. As mortgage refinancing does not qualify as the original purchase, points paid on refinancing a loan are not deductible at one time. They instead need to be amortized or deducted in part every year for the duration of the loan. Calculating the deductible amount requires division of the points paid by the term of the refinanced loan. Take the example of paying $3,000 in points and 30 years as the term of the refinanced loan, where $100 can be deducted in points every year. If already amortizing points from a previous mortgage refinancing, the full remaining balance of the points can be deducted on refinancing with a new loan. When a Refinanced Loan Is Greater Than the Previous Loan Most home values are on the rise each year, making it a big temptation to take the money in your house out for refinancing. Refinancing for an amount more than the principal of mortgage debt that is due immediately before mortgage refinancing makes the additional amount a home equity loan. Home equity loans are still subject to interest deductions within specified limits. --Deductible interest is only on the first $100,000 of the combined balances of home equity loans, with interest on any debt exceeding this limit being considered nondeductible personal interest. --Interest on mortgage debt in excess of $1 million is not deductible. --A 50% reduction for married individuals filing separate returns is given on the preceding amounts. --Interest on the debt amount more than the fair market value of the home is exempt from deduction. --On home equity debt, the interest is a preference item for Alternative Minimum Tax (AMT) use except if the home equity loan is for home improvements. This excludes interest on AMT from deduction. Already paying AMT or even approaching it could deprive you of the full tax benefit from the home equity loan interest to be paid. For example, Bruce and Jane purchased their home for $100,000 in 1984. Now the value is $250,000 and this year they went for mortgage refinancing with $60,000 of the principal remaining, converted into a new $20,000 loan. After refinancing, deductible interest is only on $160,000 of the loan balance, $60,000 of purchase debt remaining from the original loan and the maximum $100,000 of home equity indebtedness. The interest required on the remaining $40,000 ($200,000 to $160,000) of mortgage debt is non-deductible personal interest. Besides, there is no deduction on the interest being paid on the $100,000 home equity loan for AMT purposes. Points paid to mortgage refinancing are not deductible in full in the same year they were paid. This applies even if your principal residence can secure the new mortgage. The IRS holds that points paid to refinance an existing home mortgage are meant for repaying the taxpayer's ongoing indebtedness and not related to purchase or improvement of the home. Thus mortgage-refinancing points need to be deducted over the loan term. The IRS expects taxpayers to deduct these points every month for the duration of the loan period. In case a portion of the refinanced mortgage funds went into home improvement and you are capable of fulfilling the 6 tests mentioned earlier, deduction can be made on the points for improvement in the same year that they were paid out of your own funds. For the rest of the points deduction can be over the life of the mortgage refinancing loan. |
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