The Tax Implications of Refinancing Your Home Loan
While refinancing your home loan might be an excellent way to save money, it can be a double-edged sword without adequate preparation.
The tax implications of refinancing affect you differently than when you initially took on your first mortgage loan. The Tax Cuts and Jobs Act passed in 2017 changed the rules for deductions that must be incorporated into your calculations to truly understand your refinancing tax implications.
Currently, homeowners looking to deduct mortgage interest paid can itemize their tax returns up to $750,000 of principal. However, it can only be for either their first or second residence. This is a change from the previous limitation of $1 million. It seems like this would be disadvantageous for high-income taxpayers, but it actually benefits them the most.
Regardless, the tax implications of refinancing here stay the same. Homeowners can still deduct all their mortgage interest paid as long as the total doesn’t exceed $750,000 or up to $375,000 for married taxpayers filing separately.
With the housing market seemingly continuing to rise, it doesn’t make too much sense to buy a more expensive home from a tax-deduction perspective. But there is one bit of good news for homeowners that took on their original loan before December 2017.
If you’re one of those lucky homeowners, it’s possible that your original loan might be grandfathered in. That means your loan is subject to the previous $1 million limit for joint filers instead of the reduced amount of $750,000.
The quickest and most accurate way to find out is to contact your CPA or speak with a refinance lender.
Tax Deductible Items in a Refinance
There are several other items, according to the IRS, that homeowners can refinance other than their mortgage interest paid. Under the TCJA, there are deductions specifically laid out for homeowners that are refinancing.
You may have heard that you could deduct interest paid on home equity debt to help out with other expenses. While that held true before the TCJA, this deduction is now officially eliminated.
If homeowners have paid points and refinanced, there may be unamortized points available to deduct on a new refinance. In addition to the unamortized amount, homeowners can now itemize any deductible interest and amortization for paid points on a new refinance.
Whether the home is a second home, owner-occupied, a regular or cash-out refinance, homeowners can also fully deduct discount points.
Any incurred expenses, however, are not tax-deductible. The list of costs includes closing costs, appraisals, and attorney fees, to name a few.
Sometimes the tax implications of refinancing mean it’s worth waiting to refinance until your property taxes are due. That’s because when you finalize a refinance near the due date, it’s possible to deduct the taxes paid on your following income tax return.
However, it comes with a caveat. The only property taxes deductible on your next income tax return are the taxes paid that year. You’re unable to place that amount into escrow for future payments.
Cash-out refinances aren’t subject to income taxes. That’s because this type of refinancing doesn’t count as income. Instead, it’s an additional loan. But there is fine print to be aware of.
It’s possible for homeowners to deduct mortgage interest on a cash-out refinance. However, homeowners must use the money on their homes. That means the cash received from the refinance must be used to build, upgrade or buy a principal residence or second home.
If a homeowner decides to use the money to upgrade their home, it must be for substantial improvements – painting and minor repairs don’t make the cut. Capital improvement includes any renovations that are permanent or ones that increase your home’s value. That can include installing a deck, garage, replacing windows, upgrading the HVAC, and major renovations to the kitchen or bathroom.
If you do a cash-out refinance and use the funds for some other purpose than capital improvement, then it’s no longer a tax-deductible qualified mortgage debt. At this point, the refinance turns into a home equity loan taken out for tax purposes.
It’s possible to still deduct taxes on interest paid. However, it maxes out at $100,000 for a couple and $50,000 for a single taxpayer.
For example, assume you’re a single taxpayer that owes $300,000 on your home, and you took out a $400,000 cash-out refi. If you use the $100,000 to build a new garage and make additional home renovations, then it’s possible to deduct mortgage interest paid on the entire $400,000.
On the other hand, if you use the money to pay for your kid’s hefty Ivy League tuition, then you can only deduct mortgage interest paid on up to $50,000 of the additional $100,000. That means the interest paid on $350,000 is tax-deductible, but the remaining $50,000 is not.
Refinancing and Your Taxes
The tax implications of refinancing can cause anyone’s head to spin. Ultimately, refinancing can assist tax liability management and provide additional money-saving opportunities that aren’t immediately clear.
Get in contact with one of our lending experts today to see which refinancing option is best for you.