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.
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.
How To Claim Closing Cost Deduction On Income Tax Return
Look for real estate deductions on your mortgage closing cost statement.
If youve recently purchased a home, some of your closing costs are tax deductible on your federal income tax return. Its essential to know which of the many expenses incurred during closing are deductible and which are not. Check your mortgage closing cost statement for the amounts you paid.
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Tips And Tricks For Saving On Closing Costs
Saving all your cash for the down payment is a home buying mistake to avoid. Closing costs are additional thousands of dollars on top of the down payment you might not have been expecting.
But there are ways to save.
“In the seller market, we have offered to reimburse borrowers for their appraisal cost, have a network of title companies that will reduce title fees and provide grant programs for qualifying borrowers to cover down payment and some closing costs,” says Steve Twyman, branch manager with Mortgage Experts “There are options for lender credits as well.”
Of course, this is where having a strong will pay off, Twyman adds.
Orlando Miner, principal at Miner Capital Funding, LLC, recommends seeing if you can get the seller to pay for closing costs. “This is a common occurrence so don’t feel shy about asking for this. Remember the worst that can happen is they can say ‘no.'”
Miner adds that timing is key. For example, closing at the end of the month will save you on prepaid interest. “The rule is you have to pay prepaid interest from the date you close to the end of that month. So the closer you close to the end of the month the less money you pay.”
You might also want to play around with closing cost calculators. These can show you at least roughly how much you may be paying for closing costs as one lump sum.
How To Account For Closing Costs
Closings costs on a rental property fall into one of three categories:
To learn more about the specific tax rules about how to account for closing costs, you can reference IRS Publication 551 from 2018, Basis of Assets.
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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.
Over The Lifetime Of The Mortgage
You can choose to spread out the deduction for mortgage points over the life of the mortgage. There might be years in which it makes more financial sense to claim the standard deduction than it does to itemize. You can hold off, then, and only claim the points deduction in those years in which you do itemize.
When you refinance to a mortgage loan with a lower interest rate, you are replacing your primary mortgage with a new one. Because of this, a refinance is considered the same as a primary mortgage for tax purposes. This means that the same closing costs those used to prepay property taxes and those used to buy down your interest rate are the only ones that can be deducted on your federal income taxes.
If you are closing a cash-out refinance, where you refinance for more than what you owe on your existing mortgage and take the difference as a lump-sum cash payment, you might be able to use the proceeds to adjust the cost basis of your home, reducing your capital gains tax when you eventually sell. You can only do this, though, if you use the money from your cash-out refinance to make capital improvements to your home.
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Closing Costs You Can Deduct On A Home Sale
Home sellers pay closing costs, too, and these fees can take a major bite out of the sale proceeds. So its good to know a few ways to keep more of that money in your pocket.
If youve lived in your home two of the last five years, you dont have to pay taxes on the first $250,000 of profit from selling your home if youre single, or $500,000 if youre married. These amounts are exemptions, which give you much greater tax savings than deductions.
If youre selling your home for more than $250,000 more than you bought it for, anything you can do to increase your homes cost basis will lower your capital gains tax on the profit from selling your home. Your homes basis is the purchase price plus the costs you paid to maintain, improve and sell your home.
Some of the closing costs you cant deduct as a buyer or seller can be added to your homes cost basis instead, including:
- Title search and abstract of title fees
- Utility service installation fees
- Transfer or stamp tax fees
- Owners title insurance
Can You Deduct Closing Costs When Selling A Rental Property
In addition to deducting closing costs when you buy the property, there are also closing costs you can deduct when you sell a rental property:
1. Reduce selling price by closing costs paid
Sellers can deduct closing costs such as real estate commissions, legal fees, transfer taxes, title policy fees, and deed recording fees to lower the profit and lower the potential taxes owed.
Assuming seller closing costs run 8% of the sales price , deductible closing costs on the rental property sold for $164,000 would be $13,120, leaving you with a net sales price of $150,880.
2. Recapture depreciation
Recall that the annual depreciation deduction on the rental property was $5,218 per year.
Over the three years you owned the property you used a total depreciation deduction of $15,654 to reduce taxable net income. The depreciation deduction also lowered the property cost basis to $128,096, which is the original cost basis of $143,750 less the total depreciation expense of $15,654.
When the rental property is sold, you have to recapture the depreciation and pay a depreciation recapture tax based on your ordinary income tax rate, capped at 25%. Assuming you are in the 24% tax bracket, your depreciation recapture tax due would be $15,654 x 24% = $3,757 .
3. Capital gains tax
4. Defer capital gains tax with a 1031 exchange
There are three general rules to follow when conducting a 1031 tax-deferred exchange:
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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.
Selling Your Second Home
If you sell your primary residence, then the law allows single taxpayers to exclude up to $250,000 in capital gains from your income. Couples who are married and filing jointly can exclude up to $500,000 in capital gains. However, this is for sales of primary residences only. When you sell your second home, you must pay a capital gains tax on your entire profit.
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How Do Adjustments To The Cost Basis Impact Depreciation Recapture
In simple terms, depreciation recapture is the process by which the money you have saved through depreciation lowers your cost basis in the IRS view, with the result that when you sell the property, your capital gain will appear higher. Here is an example:
If you have an asset with a cost basis of $250,000 and you have taken $40,000 in depreciation while owning it , your adjusted cost basis according to the IRS is $210,000. If you sell the rental property for $350,000, your taxable gain will be $140,000 instead of $100,000. That is depreciation recapture, since you used depreciation to benefit from the aging of the property while it was appreciating.
How Much Are Closing Costs
Most lenders and industry watchers will tell you that your closing costs, on average, will cost you somewhere between 2% and 5% of the amount borrowed.
The national average closing costs for a single-family property were $5,749 including taxes and $3,339 excluding taxes in 2019, according toClosingCorp, which analyzes closing cost data for the industry.
For a more specific estimate, we used a closing cost calculator from banking service BBVA to show what these fees might look like for a $250,000 loan. After entering a 20% down payment, 30 years for the term and a 4% interest rate, the total amount of closing costs was calculated at $7,042.
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Closing Costs That Can Be Deducted When You Sell Your Home
Some closing costs may be used to reduce the taxes on selling a house. Theyre added to your basis a measure of the total costs you paid when your home was purchased. These may include:
- Owners title insurance. An owners title insurance policy protects you against prior ownership claims on the property.
- Property taxes. Only applicable if you paid any share of the sellers taxes when you bought your home.
- Title fees when you buy. These costs may include escrow, endorsements and other title search fees.
- Recording fees. Fees charged by a third party for documenting the transaction in public records.
- Survey fees. A service to confirm the propertys boundaries.
- Transfer or stamp taxes. Vary by state, but if you pay them they can be added to the basis.
- Distressed property expenses. If you purchased a home from a distressed seller and paid for any of the following items, you may be able to add them back to your basis:
- Costs of improvements or repairs
- Any back taxes or past due interest paid
- Recording or mortgage fees
- Sales commissions
You wont be able to add these expenses to the basis if the seller paid any of them when you bought your home. Check your closing disclosure to confirm who paid which closing costs to be sure.
Discount Fee Or Points
When you pay points toward your mortgage loan, it is also known as buying down the loan. These fees, paid to your lender, lower the interest rate of your loan. One point equals 1% of the loan amount. In our example of a $250,000 loan, you would pay $2,500 to buy the loan down one point. The amount the one percent buy down would impact your interest rate varies by lender, type of loan, and current mortgage rates.
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Settlement Fees Not Deductible
You “settle” or “close” your mortgage refinancing when you sign all the paperwork to officially take out the new loan and pay off the old one. A number of fees and charges may be applied at settlement. These closing costs can add up to hundreds or thousands of dollars and may include such things as:
- Appraisal fees
These costs are generally not deductible in a mortgage refinance if they’re for your residence.
What Expenses Can I Deduct
When you refinance your mortgage, several expenses can be tax-deductible and are similar to purchasing a home. You may already claim some of these deductions if you file an itemized tax return.
Some of the overlapping tax deductions for buying or refinancing a home include:
- Mortgage interest payments
- Mortgage points
- Rental property closing costs
While you pay for the qualifying expenses upfront, the deduction reduces your taxable income on your tax return. The tax deductions for a mortgage refinance can apply to your primary home, secondary home, or rental property.
Good to know:
In most cases, you can only deduct the interest payments for a mortgage or a cash-out refinance if you use the funds to buy, build, or substantially improve your main home or second home, according to the IRS.
Another notable tax reform change is reducing the mortgage interest deduction to $750,000 in qualifying debt for mortgages originating after Dec. 15, 2017.
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Which Particular Closing Costs Are Completely Non
While several of your closing costs are deductible , there are many closing costs that you cannot write off. The following are the non-deductible closing costs you should be aware of:
- Transfer taxes Many counties charge a transfer tax when the ownership of a property changes hands. Transfer taxes are non-deductible.
- Attorney fees If you used an attorney to assist in your closing, you will be responsible for paying their fees. These fees vary based on their hourly rate and cannot be written of.
Modifications To Rental Properties To Accommodate Persons With Disabilities
You can deduct expenses you incur for eligible disability-related modifications made to a building in the year you paid them. You can do this instead of adding them to the capital cost of your building.
Eligible disability-related modifications include changes you make to accommodate wheelchairs, such as:
- installing hand-activated power door openers
- installing interior and exterior ramps
- modifying a bathroom, elevator, or doorway
You can also deduct expenses you pay to install or get the following disability-related devices and equipment:
- elevator car-position indicators
- visual fire-alarm indicators
- listening or telephone devices for people who have a hearing impairment
- disability-specific computer software and hardware attachments
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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.
Can I Deduct The Closing Costs On A New House Purchase
Most expenses at closing on the purchase or refinance of a home are added to the cost of a home and are not deductible but are added to the cost basis of the home. There are a few exceptions – the following would be deductible:
1. Interest paid at the time of purchase This is sometimes included in the 1098 from the new lender.
2. Real estate taxes charged to you and not reimbursed by seller
3. Points or origination fees. On a refinance they need to be amortized over the life of the loan unless the points were used to improve your main home.
4. Private mortgage insurance costs but, if prepaid, only the amount allocable to this year based on an 84 month amortization.
NOTE: As of February, 2018, the private mortgage insurance cost deduction had not been extended to 2018 federal tax returns and cannot be deducted.
Title fees, real estate commissions, documentary stamps, credit report costs, costs of an abstract, transfer taxes, attorney fees, etc. are not deductible, but are added to the cost of the property.
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