The tax advantages to be gained from refinancing a mortgage are much the same as those available when you take out a first mortgage.
Overview
The Tax Cuts and Jobs Act that went into effect on January 1, 2018, increased the standard deduction on your federal income tax return from $12,700 to $24,000 effective with the 2017 tax year, making it less likely that you’ll benefit from itemizing deductions. Most taxpayers who don’t own homes will be better off just taking the standard deduction. However, homeowners should still check to see if the deductions available through refinancing, along with all their other deductions, will exceed the standard deduction, in which case they will be better off itemizing.
The new deduction rules affect mortgage refinances only if the initial mortgage was completed after December 15, 2017. Otherwise, the refinance will be subject to the previous tax rules.
1. Mortgage interest
Your mortgage lender should send you a Form 1098 near the end of the calendar year detailing the total interest you paid on your mortgage for that year. You may be able to deduct some or all of this figure from your taxable income, depending on factors such as the amount and how you use the proceeds from the refinance. For example, you can generally deduct the interest on a refinance when you use it to buy, build or substantially improve your principal residence, or a second residence if not rented out.
This requirement isn’t an issue when the refinance is for the same amount as the current balance on the mortgage, since all the proceeds from the refinance will automatically be used to satisfy the first mortgage. However, the requirement does become an issue in a cash-out refinance like Figure’s mortgage refinance product where the amount of the refinance, closing costs and other expenses is more than the existing mortgage. Unless the cash that is received is spent on qualifying home repairs or renovations, the interest cannot be deducted.
The mortgage interest that you deduct is also subject to an overall limit, regardless of how you use the proceeds from the refinance. The current limit is $1M for married couples filing jointly or $500K each if filing separately, provided the mortgage was closed on or before December 15, 2017. The deductible interest for mortgages closed after this date is limited to $750K for married couples filing jointly or $375K each if filing separately.
2. Mortgage points
Mortgage points are a type of prepaid interest that may be tax-deductible. Points are known by other names such as discount points, a loan discount, a loan origination fee or a maximum loan charge. Borrowers pay points upfront in exchange for a lower interest rate on the mortgage. One point equals 1% of the total loan amount. Thus, if you pay $2K on a $100K loan, you have paid two points.
The points you pay on a refinance may be deducted from your taxes over the term of the loan. For example, if you refinance a mortgage with 15 years left on it, you would deduct 1/15 of what you paid in points on each of your 15 tax returns during this period. In comparison, you can deduct all the points you pay on an original mortgage from your taxable income in the year the mortgage is originated.
3. Settlement fees
Just like other loans, refinances incur costs that you have to pay when you close. Closing costs for appraisals, attorneys, inspections and document processing generally aren’t deductible if they’re for your primary residence. However, you should be able to deduct closing costs if the refinance is going to generate income, such as when you’re refinancing a rental property. Rent from your tenants is taxable income, so any money you spend to generate that income is usually deductible.
4. Property taxes
You may have paid some property taxes when you refinanced if you closed near the time when the taxes were due. In this case, you can deduct those taxes from your taxable income provided you actually paid them during the year in which the loan closed. However, you can’t deduct funds that you paid into escrow to cover a future liability for property taxes.
5. Alternative minimum tax
The tax benefits from your refinance will have additional limitations if you are among the 0.1 percent of taxpayers with high incomes who pay the alternative minimum tax (AMT). Those who pay the AMT can still deduct mortgage interest, but they are not allowed to deduct the interest on a home-equity loan such as a refinance unless they use the proceeds to buy, build or substantially improve the home.
Summary
You can recoup some of the refinancing costs for your home through a number of tax advantages. However, be sure to review recent changes in the tax law to ensure that your deductions are still valid, as tax regulations generally have become more restrictive with respect to deductions for mortgages. You should consult a tax advisor regarding the deductibility of interest. Additional rules on deductions also apply to special cases such as taxpayers who pay the AMT or who refinance rental properties.
