Refinancing your mortgage can be an excellent way to reduce your monthly payments or access cash for home improvements, but did you know it can also help you reduce your tax burden? Thanks to the Tax Cuts and Jobs Act of 2017, there are specific deductions available to homeowners who refinance. In this blog, we’ll walk you through the tax deductions you can claim after refinancing, how long you can claim them, and how to make the most of your refinancing options.
What is a Refinance Tax Deduction?
A tax deduction reduces the amount of income you are required to pay taxes on, ultimately lowering your tax burden. For example, if you earn $50,000 a year and have $5,000 in deductions, you would only pay taxes on $45,000. In the case of refinancing, there are various deductions you may be eligible for, including mortgage interest, discount points, and closing costs on rental properties.
If you’re unsure whether you qualify for a specific deduction, we recommend speaking to a tax professional or financial planner to guide you through the process.
Itemizing Deductions vs. Standard Deduction
To claim most of the refinancing-related deductions, you must itemize your deductions. This means you’ll need to list out individual deductions such as mortgage interest and discount points, which are subtracted from your taxable income. However, you also have the option to take the standard deduction, a set amount you can claim without itemizing.
For 2024, the standard deductions are:
- $14,600 for single filers
- $29,200 for married couples filing jointly
Keep in mind, if you opt for the standard deduction, you can’t claim mortgage interest or discount points. This applies to both primary residence and investment property refinances.
Mortgage Interest Deduction
The most common deduction available to homeowners after refinancing is the mortgage interest deduction. This deduction applies to both the original loan and the refinanced loan, but with special rules for cash-out refinances.
Standard Refinancing (Rate-and-Term Refinances)
If you refinance with a standard rate-and-term refinance (without taking out additional funds), you can deduct the interest on your loan, provided:
- The loan is for your primary residence or a second home that you don’t rent out.
- You itemize your deductions.
- The lender has a lien on your property, meaning they can foreclose if you fall behind on payments.
For second homes, the deduction is still available as long as you stay in the home for more than 14 days each year or more than 10% of the days the property is available for rent.
Cash-Out Refinance Interest Deduction
With a cash-out refinance, where you borrow more than your original loan balance and take the extra money in cash, the interest deduction rules are a bit different. You can deduct interest on the original loan balance, but for the extra money you borrowed, you can only deduct the interest if you use it for capital improvements to your home.
What Counts as a Capital Improvement?
A capital improvement is a permanent upgrade or addition that increases the value of your home. Some examples include:
- Adding a swimming pool or spa
- Installing a new roof
- Adding a home office or extra bedroom
Keep in mind that routine repairs, like painting a room or fixing a leaky faucet, do not count as capital improvements and cannot be used for tax deductions.
Example of Cash-Out Refinance Interest Deduction
Let’s say you have an $80,000 mortgage balance and want to do a cash-out refinance to take out $20,000. If you use that $20,000 for a capital improvement (like adding a pool), you can deduct the interest on the entire $100,000 loan. However, if you use the funds for something non-home-related, like paying off credit card debt, you can only deduct the interest on your original $80,000 mortgage balance.
Discount Points Deductions
When refinancing, you may have the option to pay for discount points, which reduce your interest rate. Each point typically costs 1% of your loan amount. For example, on a $150,000 mortgage, one point costs $1,500. These discount points are generally deductible over the life of the loan, rather than in the year you paid them.
For primary residences and qualified second homes, discount points are tax-deductible, but the deduction is spread across the term of the loan. If your refinanced loan has a 10-year term and you paid $5,000 in discount points, you can deduct $500 each year for 10 years.
Closing Costs on Rental Properties
If you’re refinancing a rental property, you have more flexibility with what you can deduct. Since rental income is considered taxable, closing costs related to refinancing rental properties are tax-deductible. Some of these costs may include:
- Attorney fees
- Appraisal fees
- Refinance application fees
- Inspection and recording fees
In addition to closing costs, you can also deduct maintenance and repair expenses for rental properties.
How to Claim Refinance Deductions
Most tax deductions related to refinancing are claimed over the life of your loan. For example, if you refinance with a 15-year term, you’ll claim deductions annually, based on what you’ve paid in interest, over the next 15 years.
Mortgage Interest
Each year, you can deduct the interest you’ve paid on your refinanced loan. As your loan matures, a greater portion of your payments will go toward principal, meaning the interest deduction will decrease over time.
Discount Points and Closing Costs
For discount points or closing costs, you must spread the deduction over the term of the loan. For example, if you paid $5,000 in discount points and your loan has 10 years left, you would deduct $500 per year for the next 10 years.
You’ll receive a Form 1098 from your mortgage lender that shows how much interest you’ve paid, making it easier to claim your deduction.
FAQs about Refinance Tax Deductions
Are refinancing costs tax deductible? Some refinancing costs, like mortgage interest, discount points, and closing costs for rental properties, are deductible. However, not all costs are eligible, so it’s important to consult a tax professional.
Should I itemize or take the standard deduction? Itemizing may give you a larger tax break if you qualify for multiple deductions. However, it requires more paperwork and tracking. The standard deduction is simpler but may result in a smaller tax benefit.
Are refinance closing costs tax deductible? Closing costs on a refinance of a primary or secondary residence are typically not deductible. However, for rental properties, closing costs and other expenses are tax-deductible.
The Bottom Line
Refinancing your mortgage can lead to significant tax savings if you take advantage of available deductions. From mortgage interest to discount points and rental property closing costs, there are plenty of opportunities to lower your tax burden. Be sure to work with a tax professional to ensure you’re claiming all the deductions you’re eligible for and staying compliant with tax laws.
At Avanti Way Financial, we’re here to help you navigate refinancing options that best suit your needs and financial goals. Contact us today to learn how we can help you refinance with confidence!
