Mortgage refinancing tax deductions

The incredibly low interest rates have been a blessing for folks who've refinanced their home loans.

Not only do they get smaller monthly house payments, today's Daily Tax Tip also looks at the related re-fi tax benefits.

Deducting points: Points are one percent of the home loan amount. When loan rates are high, points can help you get a lower rate.

With mortgage rates already so low, many folks might not need or want to pay points for a better rate.

If, however, you do pay points -- or do in the future when rates go up, and they will -- you can deduct them as an itemized expense on your refinanced home loan.

The only drawback is that you likely won't be able to the points' full amount in the tax year in which you paid them.

Amortizing your points deduction: In most home refi situations, you must deduct points over the life of the loan.

That means on a 30-year refi where you paid $2,000 in points, you'd get an annual points deduction of around $67. Here's the math:

$2,000 ÷ 360 total payments = $5.56 per payment x 12 payments per tax year = $66.72 annual points deduction. 

Or if you round up, that's a $67 annual deduction on the mortgage interest section of your Schedule A.

There is, however, a way you deduct refi points in the tax year they were paid.

When you refinanced your mortgage, you took advantage of the new lower rate to get a little extra cash against your home's value.

If you use those extra dollars to make improvements to your home, the portion of points attributable to the improvement costs can be deducted in the year paid.

Mortgage interest: The deductibility of interest on a refinanced home loan is essentially the same as on the original mortgage.

The amount of your new refi loan that goes to pay off the previous mortgage balance is considered home-acquisition debt. That means it is fully deductible on your Schedule A.

If your refi was for more than your original home loan balance, the excess is a home equity loan. The interest on that portion also is deductible as long as it's not more than $100,000.

Home value tax issues: One other area that a refinancing homeowner needs to pay attention to in today's crazy real estate world is the home's value.

If your total refi amount is more than the fair-market value of your home -- something that could happen, especially for for underwater homeowners who will take advantage of the new Home Affordable Refinance Program (HARP) -- you generally won't be allowed to deduct interest on the excess debt.

You also might find these items of interest:

• Taking tax-smart care of your home
• Home improvements and your taxes
• Pay January mortgage early to get added deduction amount

Comments

[Baton Rouge Property]

Today's tough economy has made a tax credit designed for middle- and lower-income workers a lot more valuable and available.

[ErikBarrow]

A tremendous sense of pride comes with owning your own place. Home ownership has many benefits, and tax savings are key among them. Nice and interesting blog!

[Tom Henry]

So if many people are not paying points to have a better value, then why for is this law approved?

[Tax Relief]

These are some great tips on tax deductions! excellent way of explaining how point deduction works.

[Kay]

Good question, Gina. No, you don't lose the waiting to be claimed points if you refi. You deduct any remaining balance of amortized points in the year the mortgage ends, either due to a prepayment, another refinancing, foreclosure or similar event. But, and you knew since we're talking taxes there would be a but, this refi points deduction doesn't apply in every case. If, for instance, the second refinancing is with the same lender, the IRS says you cannot immediately deduct any remaining balance of your first refi's points. Instead, the remaining points balance from the first refi is added to your new refinance amount. You then continue to deduct them, along with any points from the second refi, for the life of your new loan.

[gina]

If you deduct points over the life of the loan what happens when you refinance again? If you took $67 as an annual deduction for 5 years, can you deduct the remaining amount on the old loan when you refinance a new one? Or do you just lose the deduction?