Is Refinancing a House Tax Deductible?

Solomon Poretsky, Demand Media writes: Homeowners refinance their mortgages for many reasons. For some, going from the risk of an adjustable-rate mortgage to the safety of a fixed-rate loan is a motivation. Others want to lower their payments or interest rates. Sometimes, you might choose a higher payment with a shorter amortization so that you can get out of debt quicker. You might also choose to pull money out of your house through a refinance. Whatever the reason, you usually won't receive significant tax benefits from the transaction.

Refinance Interest

The interest on your refinanced mortgage is deductible, subject to the same rules as your original mortgage. The Internal Revenue Service lets you write off the interest on up to $1 million of debt related to buying, building, fixing or improving your house and the interest on an additional $100,000 of home equity debt, which is money that you borrow for any reason. You can split this allowance between up to two houses and as long as your refinance is within these limits, its interest is deductible.

Refinance Points

Generally, the IRS doesn't let you write off any of your closing costs when you refinance your home. The one exception to this is when you prepay interest in the form of discount points. To be able to write off your points, you have to pay them in cash at the closing, so if you paid one point, which equals 1 percent, on a $200,000 loan, the settlement statement will need to show "cash from borrower" of at least $2,000. It'll also have to identify the point as a "discount point." If you meet these requirements, you'll be able to spread the expenditure over the life of the loan, writing off an equal portion every year. For example, $2,000 paid in points on a 30-year loan nets an annual deduction for $66.67.

When Deductions Are Lost

Refinancing your mortgage could actually end up reducing your tax deductions. The IRS lets you write off your mortgage interest, and if you refinance to a loan with a lower rate and end up paying less interest, you'll write off less. This could also happen if you refinance to a shorter term, which not only has a lower rate but also allocates more of the payment to principal and less to interest, reducing your interest payments more quickly over the life of the loan.

Rental Property Refinancing

When you refinance a rental property, the IRS' rules are different. You can write off all of your interest without any of the limitations applied to residential mortgages. Furthermore, you can write off all of your loan's closing costs, including title fees, closing fees and origination fees. To claim the write off on your Schedule E, you'll have to spread them over the life of the loan.

References

• IRS: Publication 936
• U.S. Bank: Mortgage Comparison: 15 Years vs. 30 Years
• Intuit TurboTax: What Can Be Deducted When Refinancing Rental Property?