With the recent reduction in interest rates — and reports that further cuts could be on the horizon — you may be considering refinancing your home. If you are, there are some tax implications involved that you should know about. Here’s a quick overview.
Deductions for Home Mortgage Interest
In terms of your federal income taxes, you can deduct the interest on a mortgage that qualifies as home acquisition debt, and deduct or amortize points paid to take out a mortgage that qualifies as home acquisition debt.
But beginning in the 2018 tax year, the Tax Cuts and Jobs Act (TCJA) lowered the amount that can be treated as tax-favored home acquisition debt from $1 million to $750,000 (or $375,000 if you use married filing separately status).
These new, reduced limits only apply in a refinancing context if your loan was taken out after December 15, 2017. If you refinanced a loan that was taken out on or before that date — or one that was subject to a binding contract on or before that date — it will be grandfathered in. That means your new loan falls under the older, higher pre-TCJA home acquisition debt limit ($1 million if filing jointly, $500,000 if using married filing separately status).
Refinancing an older home acquisition loan will give you a more generous deduction limit. You could also potentially treat the amount of the refinanced balance as a tax-favored acquisition debt or potentially deduct or amortize the related refinancing points.
We say “potentially” because you only get a tax benefit from mortgage interest or refinancing points if you decide to itemize your deductions. Because the TCJA increased the standard deduction amounts, it’s less likely you will gain any tax savings from refinanced mortgage interest or refinancing points — which means fewer people will be itemizing.
Standard deduction amounts vary based on your age, filing status and other criteria. To find out what your standard deduction is, use this convenient online tool from the Internal Revenue Service.
Deductions for Refinancing Points
If you do decide to itemize your deductions, points paid to refinance the remaining balance of your old loan need to be amortized over the life of the new loan.
For example: Say you refinanced your old mortgage on July 1, 2019 and paid $6,000 in points for a new 15-year mortgage with a principal balance of your old loan.
You can amortize the points over the life of that new loan (180 months). For 2019, your deduction will be $200 ($6,000 divided by 180 months multiplied by 6 months of 2019). Your amortization deductions would continue in 2020 and beyond, at the rate of $33.33 per month ($400 per year), for as long as your new loan remains outstanding.
In addition to deducting the amortized points, you can deduct financing points to take additional mortgage debt that qualifies as home acquisition debt if it’s used to finance improvements to your residence.
Deductions for Unamortized Points from Prior Refinancing
Have you refinanced your home before? Did you pay points? If so, you could have an unamortized balance remaining — meaning it has yet to be deducted — and you can likely deduct the entire unamortized amount if and when you refinance again.
For example: Suppose you refinanced your mortgage in 2014 and again in 2019. If in 2014 you took out a 30-year loan for $450,000 and paid 1 point ($4,500), you have $3,750 of unamortized (not-yet-deducted) points left over from the earlier refinancing loan. If you itemize expenses for 2019, you can deduct the unamortized point ($3,750), along with any deductible interest and amortization for points paid on the new loan.
The topics covered here are just a general overview. There are plenty of complicated tax intricacies and implications when you refinance your home mortgage. If you’d like help navigating them, please get in touch with us here at Filler & Associates.