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Mortgage Interest
With home mortgage
rates at the lowest level in years, you may be considering refinancing
your adjustable rate or higher-interest fixed-rate mortgage to lock
in what looks like a real bargain. Although taxes take a back seat
to the basic issue of whether refinancing saves enough money to
be worthwhile, you should be aware of the basic tax rules that come
into play. In some cases, you may be pleasantly surprised at the
tax deductions you'll be able to claim as a result of refinancing.
In some circumstances, however, you may wind up with fewer deductions
than you had expected.
Interest
on the new loan. The most widely applicable rules are as follows:
The interest
you pay on the new loan will be completely deductible if (1) the
new loan amount doesn't exceed the balance remaining on your old
mortgage, (2) when you got the mortgage you're replacing, you
used the loan proceeds to buy or substantially improve your home,
and (3) the new loan balance doesn't exceed $1 million.
Interest
you pay on borrowed funds in excess of the amount necessary to
retire the old mortgage also will be completely deductible to
the extent that the new money is used to substantially improve
your home (for example, adding a bedroom).
To the extent
they aren't used for substantial improvements, borrowed funds
in excess of the amount necessary to retire the old mortgage will
be deductible as "home-equity debt." Generally, the interest paid
on up to $100,000 of that debt is deductible as home mortgage
interest regardless of how the proceeds are used (but you can't
deduct the interest if you use the proceeds to buy tax-exempt
bonds).
What these
rules boil down to is that the interest you pay on the new loan
usually will be deductible if (1) you're refinancing your old
mortgage dollar-for-dollar, (2) your new loan amount exceeds the
old mortgage's remaining balance and you use the new money for-substantial
improvements to your home, or (3) the new loan money isn't used
for home improvements, but doesn't exceed $100,000.
Points
on the new loan. Points paid in connection with buying or
substantially improving your main home are currently deductible.
However, if you must pay points on a refinance loan, this charge
will be currently deductible only if you pay the charge out of
your own cash at the closing (that is, the charge isn't withheld
from the mortgage loan); and only to the extent that the new loan
proceeds are used to substantially improve your home. So if you
refinance your existing home mortgage and use none of the new
loan for substantial improvements to your home, any points you
pay on the transaction won't be currently deductible. Instead,
you'll have to deduct the points over the life of the new mortgage.
Deductions
from bailing out of the old mortgage. You may have to pay
the bank a prepayment penalty to pay off your existing mortgage.
If that's the case, the penalty will be fully deductible if the
interest you paid on the retired mortgage was deductible as home
mortgage interest.
Points
balance on the old mortgage. You may have had to pay points
when you got the mortgage you now want to refinance. If you were
required to deduct the points over the life of your existing mortgage,
the part of the points that you haven't yet deducted may be deducted
currently as interest (again, assuming that the interest you paid
on your existing mortgage was deductible as home mortgage interest).
For example:
Suppose
you refinanced your home mortgage several years ago and used the
proceeds to pay off in full your original home mortgage. Your
refinancing mortgage (loan #2) was a 30-year fixed-rate loan for
$100,000. You paid three points ($3,000) on the refinancing. Because
all of the loan proceeds were used to pay off the original mortgage
and none were used to buy or substantially improve your home,
all of the points on the refinancing loan had to be deducted over
the loan term. This year, you refinance again with a lower-interest
mortgage (loan #3) when there's a remaining (not-yet-deducted)
point's balance of $2,400 on loan #2. You can deduct the $2,400
as home mortgage interest on your 1998 return.
Be sure to
consult with a tax advisor for proper planning and implementation
of tax savings ideas to be sure they are right for you.
C.
David Pitzer, CPA, PC
118
Two Mile Pike
Goodlettsville, TN 37072
(615) 851-2727
Fax: (615) 851-8711
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