Refinancing a Home
Mortgage
What expenses can be
deducted during tax preparation and what qualifies as points?
Mortgage rates
were on the decline again in 2002 and this always provides opportunities
for homeowners. It's sometimes difficult to decide whether refinancing
your home mortgage is a good move. Generally, refinancing when interest
rates are lower than your current rate can lower your monthly payment and
possibly give you some extra cash for home improvements, vacations, or a
new car.
It is important
to know when the interest you will be paying qualifies as tax deductible
mortgage interest during tax preparationand when it will not. As a general rule, if you
refinance your mortgage for the same amount as the remaining balance, all
your interest remains fully deductible (assuming the total amount of the
mortgage is $1-million or less).
If the new mortgage balance is more than the
remaining balance of the old mortgage, the additional interest may be
deductible. The additional interest is deductible if the cash taken
out at closing is used to add onto or substantially renovate your home.
If the additional cash taken out is not put into the home, then the
interest on up to $100,000 more than the old mortgage should be deductible
as a home equity loan.
The closing costs
you pay - such as for an appraisal, filing fees, or recording fees - are
not tax deductible.
Income Tax Planning for Deduction of Points
Over the Life of the Loan
If you pay points, which are usually a percentage of the
mortgage, they are deductible as interest during tax preparation. Whether they are deductible in
full in the year you pay them depends on what the loan proceeds were used
for. If you merely refinanced your mortgage to take advantage of a lower
rate, the points are deducted ratably over the term of the loan and should
be projected to future years in your income tax planning. However,
if you used part of the refinanced mortgage proceeds to improve your main
home, the points paid on the part of the loan used for improvements are
deductible in full.
If you refinance a
mortgage on a second home you own, the points paid can only be deducted
over the term of the loan, even if you use the proceeds to improve your
second home.
When you pay off a refinanced mortgage, whether you sell your home or
do another refinance, any remaining points on the paid off mortgage that
have not been deducted may be deducted in the year the remainder of the
mortgage is paid off. Be sure to take the remaining points into
account during your income tax preparation for the year of sale.
