Do: Itemize To Claim Your Mortgage Interest Deduction
The personal exemption put in place by the TCJA has risen for tax year 2021 to $25,100 for married couples filing jointly. This increased standard deduction may or may not make it worth your while to itemize your return to get the break the mortgage interest deduction can bring. As has been the case last year, TCJA made things a bit more complicated as there is also a $10,000 limit on deducting State and Local Taxes .
If the total of the two total more than $25,100 , it’s probably worth it to itemize your return, but there’s no simple answer as to whether it is or isn’t.
As an example, if you are in a high-tax state and will hit the $10,000 SALT cap, that leaves you with $15,100 gap to fill with mortgage interest before you get over the threshold where itemizing may make sense. For a married couple with a mortgage at 3%, you’ll need a loan amount of $510,000 to have paid $15,100 in interest in the first year of the loan.
Since interest costs diminish over time from there, hitting this mark in future years can be increasingly difficult. For example, the amount of interest paid in the second year of the loan example above totals only $14,831, so you’ll need other deductible expenses to help close the gap.
So, is it worth it to itemize your return or not? You have to run the numbers to find out, or let your tax professional figure it out for you. If it is worth it, you’ll be filing a 1040 Schedule A.
Are Settlement Fees Deductible
In short, no.
When you pay a number of fees and charges after settling your mortgage refinancing agreement, you cant deduct these payments.
These include but are not limited to: attorney fees, legal fees, and inspection costs.
You can deduct some expenses when refinancing, but these generally dont apply to residences.
How Much Mortgage Interest Can I Deduct
You can still deduct the interest you pay on your mortgage loan each year. But the Tax Cuts and Jobs Act did place some limits here, too. If you purchased your home before Dec. 16, 2017, when the act went into effect, you can deduct the interest payments you make on up to $1 million in mortgage debt. If you bought your home after that date, you can deduct the mortgage interest you pay on up to $750,000 in mortgage debt.
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Which Ones Are Deductible
Most closing costs for the refinance of an investment property are not deductible. The mortgage interest and property taxes can be deducted, but the rest are added to the cost basis for the asset and are depreciated. Depreciation in this context refers to the investors ability to deduct the cost of an asset over the course of its usable lifetime. The IRS allows residential rental property to be depreciated over a period of 27.5 years. If you are depreciating commercial property, the timeline is 39 years.
For example, if you have a rental property with a cost basis of $100,000, and $10,000 of that value is attributable to the land, the remaining $90,000 is depreciated by dividing it by 27.5. Each year, the property depreciation allowance is $3,272.72.
Points Are Normally Tax Deductible
While you are usually out of luck to tax deduct your closing costs, you can usually tax deduct any points that you paid on your mortgage refinance. Points are paid in most cases so that you can get a lower interest rate. In some cases, you may pay several thousand dollars in points, so this is a significant deduction on your taxes. To itemize the point deductions, you need to use Schedule A on your 1040 return. In many cases, the IRS will require you to tax deduct the points over the loans life, whether it is 15 or 30 years.
If you are using the money from a refinance mortgage program to pay for some improvements to your house, some of the points that you paid may be fully deductible in whatever year you took them. However, the improvements need to add some value to the home. IRS guidelines also state that you need to use your home as collateral for the refinance loan. Also, the paying of points must be a customary practice where you live, and you are not allowed to pay more in points than what the lender normally charges.
Further, you have to use the cash method of accounting to tell the IRS what your income is, as well as what you are deducting. A lender also may not charge you any points to waive any other mortgage loan fees and points that you might pay. Talk with a trusted tax adviser and consider the pros and cons of a refinance with no closing costs or fees.
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Tax Implications Of Refinancing Your Homes
View All | September 2019 Newsletter Edition
You may be thinking about refinancing this year to take advantage of falling interest rates. Or you may have refinanced your home mortgage last year and have yet to file your 2018 return . Either way, there are important federal income tax implications. Heres what you need to know.
Deductions for Home Mortgage Interest
For federal income tax purposes, you can deduct interest on a mortgage that qualifies as home acquisition debt. In addition, you can deduct or amortize points paid to take out a mortgage that qualifies as home acquisition debt.
However, for 2018 through 2025, the Tax Cuts and Jobs Act reduced the amount that can be treated as tax-favored home acquisition debt to $750,000 .
Fortunately, these reduced limits apply in a refinancing context only if you refinance a loan that was taken out after December 15, 2017. If you refinance 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, the new loan is grandfathered in under prior law. That means the new loan is subject to the more-generous pre-TCJA home acquisition debt limit of $1 million .
So, if you refinance an older home acquisition loan, the more-generous limits will apply, and you can potentially treat that much of the refinanced loan balance as tax-favored home acquisition debt. Plus, you can potentially deduct or amortize the related refinancing points as well.
Rules For Making Tax Deductions On Mortgage Interest
First of all, the loan must be on either your primary residence or a secondary residence. If you take the deduction on a second residence, this cant be a rental property.
The loan must be secured against your home. In other words, your home is acting as collateral. As a result, your home will be foreclosed in the event you dont meet your mortgage repayments.
Youre also only able to claim this tax deduction if you itemize on your taxes. When itemizing, youre adding every deductible expense individually and then deducting the total amount.
You cant take this tax deduction if you take the standard deduction, which everyone is entitled to regardless of their circumstances.
Online tax platforms, like TurboTax can help you figure out whether you should itemize or take the standard deduction. These tax preparation platforms will add up which deductions youre eligible for and determine whether the standard deduction is worth more or less.
To do this for the mortgage interest tax deduction, youll need to wait for your lender to send you Form 1098, which will tell you how much interest you paid during the last tax year.
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Which Closing Costs Are Tax Deductible
Unfortunately, not many closing costs are tax deductible. Two exceptions are any points you pay for to reduce your loans interest rate and any property taxes you pay in advance.
Property taxes are always deductible. When you take out a mortgage loan, though, youll usually have to pay some property taxes upfront, before they are due. Thats because lenders typically create an escrow account for borrowers.
In an escrow arrangement, youll pay extra money with your monthly mortgage payment to cover the costs of your yearly property taxes and homeowners insurance. When your insurance and tax bills are due, your lender will dip into these funds and pay them on your behalf. When tax time rolls around, you can deduct any property taxes that you paid in advance.
Mortgage points are also tax deductible. Home buyers purchase these points to lower the interest rate on their mortgages, with each point costing 1% of their total loan amount. For instance, one point on a mortgage loan of $200,000 would cost $2,000. Each point typically drops a borrower’s interest rate by 0.25%. One point, then, would lower a mortgage interest rate of 3% to 2.75% for the life of a mortgage loan.
Points can pay off in lower interest costs throughout the life of a loan. They can also help at tax time. The IRS allows you to deduct the full amount of your points in the year borrowers pay for them. To claim this deduction, your mortgage must be used to buy or build your primary residence.
Example Of How Mortgage Points Can Cut Interest Costs
If you can afford to buy discount points on top of the down payment and closing costs, you will lower your monthly mortgage payments and could save lots of money. The key is staying in the home long enough to recoup the prepaid interest. If you sell the home after only a few years, or refinance the mortgage or pay it off, buying discount points could be a money-loser.
Here is an example of how discount points can reduce costs on a 30-year, fixed-rate mortgage in the amount of $200,000:
In this example, the borrower bought two discount points, with each costing 1 percent of the loan principal, or $2,000. By buying two points for $4,000 upfront, the borrowers interest rate shrank to 3.5 percent, lowering their monthly payment by $56, and saving them $20,680 in interest over the life of the loan.
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Will Refinancing Make My Property Taxes Go Up
No, refinancing will not have a direct impact on your property taxes even if you get a new, higher appraisal when you refinance. Thats because your property taxes are assessed by your local tax authority based on its own valuation of your homes value. That wont be swayed by your mortgage appraisers valuation.
However, if the lenders appraisal shows that your home is worth much more than your tax authority thinks, that may be a sign that youre living somewhere with rapidly rising property prices. So you may be in for a hike in property taxes next year. But thats solely down to home price inflation.
Additional Requirements To Be Eligible To Deduct Mortgage Points
- The mortgage is for your primary residence
- Points have to be a percentage of your mortgage total
- Points must be normal in your area
- The points must not be excessive in your area
- You have to use the cash accounting method when filing taxes
- The points cannot be used for items that are normally standalone fees
- You cannot be paying for your points with borrowed funds
- You have to itemize your points clearly
In the event that you are unable to deduct points this tax year, you may be able to deduct them over the life of the loan.
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How To Claim Refinance Tax Deductions
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The Tax Cuts and Jobs Act of 2017 had several implications for refinancing. Understanding the new tax rules can help you minimize your tax burden after you refinance your house. Well talk about some of the deductions you can claim on your federal taxes after a refinance, and how long you can claim them.
Deducting Mortgage Points Over The Life Of The Loan
- The loan is secured by a home
- You use cash accounting
- The loan term is 30 years or less terms over 10 years must be comparable to others offered locally
- Either the loan amount is $250,000 or less, or:
- For loans of 15 years or less, no more than four points were paid
- For loans of 16 years or more, no more than six points were paid
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The Us Tax Code Continues To Incentivize Homeownership
Even if you cant deduct all your closing costs, the U.S. tax code still encourages people to buy homes through the mortgage interest and property tax deductions. Visit our real estate Learning Center if you want to learn more about the tax advantages of investing in real estate.
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Are Refinance Closing Costs Tax Deductible On Rental Property
There are often good reasons to refinance a rental property. If your equity in the property has increased, you may want to access some of the cash available to leverage by investing in additional assets. Or, perhaps interest rates have declined and you can refinance at a lower cost. Another possibility is to change the length of the loan term. Whatever your reason is, investigate carefully before deciding.
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How Much Mortgage Interest Is Taxdeductible
You can deduct all your mortgage interest up to $750,000 per property if you used the loan to purchase your home or substantially improve it. Any such improvements must increase its value.
But you wont be able to deduct mortgage interest on any portion of your loan that youve used for other purposes.
So, if you got a cashout refinance and spent the money on debt consolidation, starting a business, funding a wedding or vacation, or any other purpose that doesnt involve home improvements, you wont be able to deduct that interest.
How To Receive A Mortgage Interest Deduction
In order to receive a mortgage interest deduction, you need to ensure that you obtain and fill out all of the appropriate forms. At the beginning of the year, you should receive a Form 1098 from your mortgage lender. The 1098 will state exactly how much you paid in interest and mortgage points over the course of the year, and act as proof that youre entitled to receive a mortgage interest deduction. Be aware that you will only receive this form if you have paid at least $600 in interest during the tax year.
To qualify, you will also need to itemize your deductions and report them on Schedule A, Form 1040. This form will have you list all of your deductions, including donations to charity, medical expenses and the information about your mortgage interestfound on your 1098.
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What Are The Closing Costs
When you refinance , there are costs involved. The closing costs are expenses that the owner pays to complete the transaction. When buying a property, some closing costs are paid by the seller and some by the buyer, but in a refinance transaction there is no seller. Closing costs often include loan origination fees , appraisal fees, title charges, survey costs, recording fees, and taxes.
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How To Deduct Points From A Refinanced Mortgage Or Loan For A Second Home
If you refinanced your mortgage, the points you paid are not deductible in the year you paid them, unlike the points you paid when you first took out your mortgage. For refinanced mortgages, you have to deduct the points equally over the life of the loan. This also goes for loans you take out to buy a second home or investment property.
HERE’S HOW: Divide the points paid by the number of payments to be made over the life of the loan. EXAMPLE: If you paid $2,000 in points and will make 360 payments on a 30-year mortgage, you can deduct $66.72 each year, assuming you make 12 mortgage payments in a year.
There is an exception: If you use part of the money for home improvements, you can deduct the portion of points related to the improvements in the year you paid them.
EXAMPLE: If you refinanced your $200,000 mortgage with a new 30-year loan of $250,000, paid $2,000 in points and used the extra $50,000 to make home improvements, you can deduct 20 percent or $400 of points in the year they were paid. The remaining points paid must be deducted equally over 360 monthly payments or $53.28 each year.
NOTE: If your mortgage ends early because you paid it off, refinanced it with another lender or sold the home, you can deduct any remaining points for the mortgage in that year. So, in the above example, if you sold the house the following year, you can deduct $1,546.72 .
Always consult your tax adviser. For more information, read IRS Publication 936.