Refinancing and income taxes

Ellen Sinkey PHOTO CREDIT: Contributed

With interest rates at all-time lows, refinancing can be a great money-saving move, but it can impact your taxes.

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.

Since the Tax Cuts and Jobs Act (TCJA) legislation was passed in 2017, there are new guidelines for refinancing deductions. Following are some of the tax rules you should be aware of before deciding to refinance your home. Hopefully, it will 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 $750,000, or $375,000 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 Dec. 15, 2017, you’re in luck. Your refinanced loan might be grandfathered in under the prior law. That means you’ll be subject to the more generous limit of $1 million instead of $750,000 for joint filing — or $500,000 instead of $375,000 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 might 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 consider. For example, under the 2017 law, standard IRS deductions increased. These might cut many of the deductions homeowners could previously count on. New deductions are as follows:

Individuals and 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 might be worth it to itemize. Your tax preparer or financial adviser will be able to run the numbers and outline the benefits.

What’s tax deductible with a home loan refinance?

A common question is “what home buying expenses are tax deducible?” 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).

Home equity: 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; however, you can deduct interest on funds used for capital improvements as long as it falls within the home loan debt limits mentioned above.

Points: Have you previously refinanced and paid points? You might have an unamortized — not-yet-deducted — balance remaining. If so, you might 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.

HOI: Homeowner’s insurance payments are not considered tax-deductible.

Closing costs: 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.

Property taxes: If you finish your refinance on or near the date that your property taxes are due, you could end up paying those taxes at the closing. If that’s the case, you might 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) made during the year are deductible. You can’t deduct cash put into escrow for future property tax payments.

Refinance tax implications are complicated, and the preceding information is general in nature. You should discuss your plans with your tax preparer to better understand the advantages and disadvantages of refinancing from a taxation angle. Further information is available in IRS Publication 936.