Tax Implications of a Mortgage Refinance

by Mark Kennan

    When rates fall or you need to take out some money against the value of your home's equity, a refinance can help meet your needs. If you're worried about the potential tax implications, such as losing your mortgage interest deduction, don't be. The Internal Revenue Service allows you to continue taking your existing deductions and may even allow you some additional ones.

    Generally, only debt used to buy, build or repair your home qualifies as home acquisition debt. However, according to IRS Publication 936, any debt that you refinance continues to count as home acquisition debt. This makes the interest on the refinanced debt continue to qualify for the home mortgage interest deduction. As a result, you can deduct the interest on up to $1 million of refinanced mortgage debt. If you're married but filing separately, each spouse can deduct the interest on up to $500,000 of refinanced debt.

    When you refinance, you may have the option to cash out extra money if you have equity in your home. If you do, the IRS classifies this new debt as home equity debt. Home equity debt is still deductible, but the limits are much lower. As a result, you can only deduct the interest on the first $100,000 of home equity debt ($50,000 if married filing separately). However, if you use the proceeds to substantially improve your home, your additional debt counts as home acquisition debt and qualifies for the higher limits.

    When you refinance, you may prepay interest, called points, to get a lower interest rate. If you do so, and the points aren't instead of paying charges that are usually separately stated, you can deduct those points over the life of the refinance. Charges that are usually stated include legal fees, titling costs and inspections. For example, if you pay $5,040 in prepaid interest points and you refinance for another 30 years, you can deduct $14 per month, or $168 per year.

    If you have points left over, either because you elected to spread the deduction over the life of your original mortgage or you refinanced in the past, you can deduct them all in the year you refinance. For example, if you still have $1,000 of points you haven't deducted, you can deduct them all in the year of the refinance. The exception to this deduction is if you refinance with the same financial institution. If you refinance with the same lender, you have to spread those points over the life of the refinance. For example, if you refinance with the same lender for another 20 years, that $1,000 gets broken into a $50 deduction each year.

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    About the Author

    Mark Kennan is a freelance writer specializing in finance-related articles. He has worked as a sports editor for "Ring-Tum Phi" and published articles on a number of online outlets. Kennan holds a Bachelor of Arts in history and politics from Washington and Lee University.

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