Tax Deductions for Interest on a Mortgage Refinancing
Before you consider refinancing your mortgage, it's smart to familiarize yourself with the tricky tax rules on what is or is not deductible when it comes to interest payments. That's especially true following changes in the tax law that went into effect on January 1, 2018. The majority of those changes are set to expire at the end of 2025 unless Congress reauthorizes them.
Julian Block, a tax attorney in Larchmont, New York, offers some helpful information to homeowners who aren't sure whether they are still able to deduct their interest payments from their federal taxes.
Mortgage Date Milestone: December 15, 2017
The new deduction rules apply to the refinancing of an initial mortgage that was completed after December 15, 2017. If the initial mortgage went into effect on or before that date, it has been grandfathered in and the new rules regarding refinancing don't apply to it.
Mortgage Refinancing Rules for Tax Deductions
Whether borrowers are entitled to deduct interest on the amount in excess of their existing mortgage depends on how they use the proceeds of the refinancing and the amount of the proceeds. When borrowers use the excess amount to buy, build, or substantially improve a principal residence or a second home, their interest payments come under the rules for home acquisition loans.
Borrowers can now deduct home mortgage interest on the first $750,000 (or $375,000 each if married filing separately) of indebtedness, according to the Internal Revenue Service. However, the previous, higher limitation of $1 million (or $500,000 each if married filing separately) applies if you are deducting mortgage interest from indebtedness incurred before December 16, 2017.
When borrowers use the excess amount for any purpose other than buying, building, or improving a home, another set of rules prohibits deductions for payments of interest on "consumer loans." This wide-ranging category includes credit card bills, auto loans, medical expenses, and other personal debts such as overdue federal and state income taxes. There is, though, a limited exception for interest on student loans, depending on your income.
Home Equity Change
Most borrowers were previously able to sidestep these restrictions on deductions for consumer interest, thanks to the rules for home equity loans. Those rules allowed them to deduct all the interest as long as the amount in excess of the existing mortgage plus all other home equity loans did not exceed $100,000, or $50,000 each for married couples filing separate returns.
A change in the new law requires the home equity loan to be used to buy, build, or make improvements on a home to be deductible; previously, the proceeds from the home equity loan could have been used on anything. In addition, the collateral for the loan must be the home for which the improvements were made, and the combined debt on the home can no longer exceed its original cost.
When refinanced loans are partly home acquisition loans and partly home equity loans, there is again an overall limit of $750,000, or $375,000 each for married couples filing separately.
Deductions for Taxpayers Subject to the Alternative Minimum Tax
Yet another restriction applies to borrowers burdened by the alternative minimum tax, or AMT. The AMT still allows deductions for interest payments on home acquisition loans but denies a deduction for interest on home equity loans for first or second homes unless the loan proceeds are used to buy, build, or substantially improve the dwellings.