Tax Benefits of Refinancing
The tax benefits of home ownership can potentially save you hundreds of dollars every month. With a little planning you can make sure the dollars you save in refinancing your mortgage stay in your pocket. You might just discover previously unknown tax deductions along the way.
In the early years of the life of a loan, payments are mostly on the interest owed rather than on the principle. If you itemize your deductions instead of using the standard deduction, you might stand to benefit . If you and your spouse file jointly, you can deduct interest payments to a maximum of $1 million. For example, let's say your original mortgage was $300,000. You might take out a new $350,000 refinanced mortgage and pay two points, or $7,000. (A point is an interest charge equal to 1% of the total loan amount that is paid upfront on the close the loan.) As seen by the Internal Revenue Service, the first $300,000 of your new loan is treated as home-acquisition debt. The interest paid on this debt qualifies as an itemized deduction. The $50,000 balance of the new loan is treated as home-equity debt and also qualifies as an itemized deduction. You can amortize the home-acquisition-debt points over the life of the loan. The points related to the home-equity debt can be amortized in the same proportion as the interest, but make sure the home-equity debt is $100,000 or less and the value of the home isn't exceeded by the acquisition debt plus the home-equity debt.
If your refinanced mortgage is more than your original loan, you can use the difference to improve your home and deduct a dollar amount equal to the percentage of points paid in the first year. Anything within reason that improves your property value, such as improving the back deck or repairing the driveway, can count towards the deductible interest. Interest taken out for expenses not related to home improvement can also be taken as a deduction, but only within certain guidelines. But remember, the maximum deduction in 2007 for the life of the loan is $100,000.
Amortization: Pros and Cons
The points you'll pay when you first purchase your home are deductible in the tax-year in which the property was purchased. For example, if you paid one point on the origination fee of your new $300,000 home, your tax deduction that year will be $3,000. When you refinance your mortgage, the deduction for the amount paid will be amortized over the course of the loan, but the savings will still add up. Returning to the example, if you pay two points on the $350,000 loan when you refinance, the tax deduction of $7,000 would be amortized over 30 years. But, if you decide to refinance again, or you sell the house, you can write-off the unclaimed portion of the deduction. Additionally, i f you have refinanced before, you might have unamortized points that would be allowed in full the year you refinance.
You can learn more about the tax benefits of mortgage refinancing from the IRS Publication 936, Home Mortgage Interest Deduction, and by contacting your local tax advisor.