Can You Deduct Finance Charges When You Refinance Your Mortgage?

by Mark Kennan, studioD

Most people know that refinancing your mortgage to a lower rate will save you money on your monthly payments. But, if you stop there, you might be missing out -- because it could also save you money on your taxes. What you can deduct and when you take the deduction depends on whether you are refinancing a home mortgage or a mortgage on an investment rental property.

Home Mortgage Refinancing Costs

Most costs aren't deductible when you're refinancing your home mortgage. Things like the lender's fees, attorney fees and appraisal fees aren't deductible. But, if you pay prepaid interest, that amount can be a deductible expense. Prepaid interest is often called an origination fee, discount points or maximum loan charges. For example, your lender might offer you a lower interest rate on your mortgage refinance if you pay a point or two.

Time Frame

Generally, you must deduct the points paid over the life of the refinance. For example, if you refinance to a 30-year mortgage and pay $3,600 in points, you can deduct $120 per year over the life of the refinance. But, there is an exception if you do a cash-out refinance and use the proceeds of the loan for home improvements: you can deduct the entire amount of the points allocatable to the cash-out portion if (1) the refinance is on your main home; (2) the payment of points is a regular practice in your area; (3) you didn't pay more than the amount generally charged; (4) you use the cash method of accounting --and most taxpayers do; (5) the points represented interest, and not another name for other fees, such as attorneys fees; and (6) you paid at least as much at closing as the points. For example, say you refinanced your $100,000 mortgage for $125,000 and used the $25,000 for home improvements. Assuming you meet the conditions, you can deduct the points on the $25,000 immediately and the remaining points over the life of the loan.

Rental Property

When you refinance a mortgage on a rental property, you can deduct all the costs associated with getting the new loan, including fees for the lender and attorney, appraisal costs and points on the loan. However, you are limited to deducting these costs over the life of the loan. For example, if you pay $4,500 in costs on a 15-year refinance, you can deduct $300 as an expense each year when figuring your net rental income.

Tax Reporting

To write off your home mortgage refinance costs, you need to itemize your deductions on Schedule A and give up your standard deduction. By contrast, the deduction for rental refinancing costs goes on Schedule E, which determines your gain or loss from rental activities. Schedule E then transfers the net rental income to your Form 1040 tax return, so there's no need to itemize to claim the deduction.

About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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