Refinancing can be a great money-saving move. But it can also impact your taxes both positively and negatively.
From a tax implication perspective, refinancing is viewed differently than an initial mortgage. Because it’s seen as “debt restructuring,” the deductions and credits that can be claimed with a refinance aren’t as beneficial as when you initially took out your home loan.
Additionally, since the Tax Cuts and Jobs Act (TCJA) legislation was passed in 2017, there are new guidelines for refinancing deductions. This article will bring you up to speed on some of the tax rules you should be aware of before deciding to refinance your home. Hopefully, it’ll provide you with tips on how you can minimize potential tax surprises.
Refinance tax implications
According to the TCJA, there are strict caps on the amount of deductible interest you can claim on your taxes. For example, interest can only be deducted on mortgages of up to $750K, or $375K for married taxpayers filing separately. For homeowners in expensive markets, this makes it a lot less favorable (from a tax write-off perspective) to purchase a pricier home.
If you’re refinancing a home loan that originated on or before December 15, 2017, you’re in luck. Your refinanced loan may be grandfathered in under the prior law. That means you’ll be subject to the more generous limit of $1 million instead of $750K for joint filing — or $500K instead of $375K for married filing separately – and be able to treat much of the refinanced loan balance as tax-favored home acquisition debt. For federal income tax purposes, that means you may be able to deduct interest on your mortgage loan or potentially deduct or amortize refinancing points.
Standard deductions vs. itemized
There are other changes to take note of. For example, under the 2017 law, standard IRS deductions increased. These may cut many of the deductions homeowners could previously count on. New deductions are as follows:
- Individuals & married couples filing separately: from $6,350 to $12,000
- For heads of household: from $9,350 to $18,000
- For married couples filing jointly: from $12,700 to $24,000
These revised benchmarks reduce the chance that you’ll itemize deductions and gain any tax savings from your refinancing. However, if the total of your itemized deductions equals more than the standard deduction, it may be worth it to itemize. Your tax preparer or financial advisor will be able to run the numbers and outline the benefits.
So, what’s tax deductible in a home loan refinance?
A common question among homebuyers is “what home buying expenses are tax deductible?” Well, some of the new TCJA tax rules apply specifically to taxpayers who are refinancing. Here’s what you can expect under the new tax law:
Mortgage interest and capital improvements
Mortgage interest can be deducted if you have a cash-out refinance, meaning you’re taking money out of the home equity you’ve built up to date. But, there is a caveat: You must use the cash to buy, build or substantially upgrade a principal residence or a second home with capital improvements. A capital improvement is defined as any permanent renovation or addition that increases your home’s value (like replacing windows or a roof, adding a garage or deck, renovating a kitchen or bathroom, introducing a home security system, or upgrading an HVAC). Things like interior or exterior painting or making minor repairs don’t count.
Prior to the 2018 tax year, homeowners could deduct the interest paid on home equity debt for reasons other than to renovate your home (for example, for college expenses). This home equity deduction was eliminated with the TCJA tax plan.
Have you previously refinanced and paid points? You may have an unamortized — not-yet-deducted — balance remaining. If so, you may be able to deduct that entire unamortized amount when you refinance again, along with any deductible interest and amortization for points paid on the new loan. Discount points are fully deductible, regardless of the type of property you’re refinancing or whether you’re doing a regular or cash-out refi.
Homeowner’s insurance payments are not considered tax-deductible.
Closing costs, as well as other expenses not included in the closing costs, are not deductible. This can include appraisal fees, property title search fees, attorney fees, and other administrative expenses.
If you finalize your refinancing on or near the date that your property taxes are due, you may end up paying those taxes at the closing. If that’s the case, you may be able to deduct the property taxes paid during a refinance on your next income tax return. However, only property tax payments that you (or the mortgage servicer) actually made during the year are deductible. You can’t deduct cash put into escrow for future property tax payments.
Get started on refinancing
Refinance tax implications are complicated. Above all else, you should discuss your plans with your tax preparer to better understand the advantages and disadvantages of refinancing from a taxation angle.
If you decide to refinance, it’s always easier and more straightforward when you discuss your options with an experienced mortgage professional. Find a local loan officer here.