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Refinancing can save you money with lower monthly payments and a lower interest rate, but you usually have to pay a number of upfront costs to close on a loan, including various types of fees and possibly discount points. Knowing which of the costs are deductible, and whether to take the deduction when you pay it or over the life of the refinance, helps put a few dollars back in your pocket come tax time.
Fees Are Nondeductible
Fees are different from points when it comes to taking a tax deduction for refinancing costs. The fees are generally not deductible, but you can deduct your discount points paid if you meet the requirements and you itemize your deductions. Nondeductible fees include attorney's fees, appraisal fees, title fees or inspection fees. In addition, the Internal Revenue Service disallows a deduction for points if your lender mischaracterizes one of these fees as points. For example, if the lender would have charged you $250 for an inspection, but instead calls it "points," you still can't deduct it.
Deductible Refinancing Discount Points
Refinancing points refer to costs you choose to pay to get a lower interest rate on your refinance rather than fees you have to pay as part of the loan. These costs may be referred to as "loan origination fees," "maximum loan charges," "loan discounts" or "discount points." To be deductible, these costs can't take the place of costs that should be reported separately. In addition, to qualify, your refinance term cannot be longer than 30 years and, if your refinance is for more than $250,000, you cannot pay for more than four points for refinances for less than 15 years or six points for refinances between 15 and 30 years.
Deduction Taken Over Time
Typically, when you pay points on your refinance, you have to spread the cost over the term of the refinance. For example, if your refinance term is 20 years, or 240 months, and you pay $6,000 in deductible costs, your deduction is valued at $25 per month. If you refinance with four months to go in the year, you could deduct $100 that first year. In future years, you can deduct $250 per year until the final year, in which you can deduct only $150.
Home Improvement Exception
If you did a cash-out refinance and you used the proceeds for home improvements, you can treat the refinance as if it was a first mortgage on the home. If the refinance meets the other requirements, including being for your main home and the points were calculated as a percentage of your refinance, you can deduct the entire amount in the year that you pay them. Not only do you not have to keep track of your deductions each year, you get to claim the tax break sooner.
Previously Undeducted Points
If you've refinanced in the past, you might have costs remaining from that refinance that you haven't been able to deduct yet. If so, you can deduct those costs in the year you refinance. For example, imagine that you refinanced to a 20-year mortgage five years ago and paid $8,000 in points. Most likely, you've been able to deduct only one-fourth, or $2,000, of those points. In the year you refinance, you can write off the remaining $6,000 of previously undeducted points.
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