How does a refinance in 2018 affect your taxes?

It used to be that being a homeowner could offer some big tax advantages, not the least of which are perks related to that mortgage you pay every month. With the Tax Cuts and Jobs Act (TCJA) revising certain aspects of the tax code starting with tax year 2018, it's much less of a certain thing than it used to be.

If you refinanced your mortgage in 2018, there are some specific "dos" and "don'ts" you need to know prior to filing your income taxes, as well as a few pointers that might help you lower your tax bite.

The following information will help to reduce your federal income taxes and get you prepared for mortgage-related tax issues in 2018 and beyond.

Do: Itemize to claim your mortgage interest deduction

New personal exemptions of up to $24,000 for married couples filing jointly may or may not make it worth your while to itemize your deductions to get the mortgage interest deduction break on your taxes. The new law does make things a bit more complicated, though, and when coupled with limits on deducting State and Local Taxes (SALT) there's no simple answer as to whether it is or isn't. You have to run the numbers.

Which tax-deductible mortgage amount limits apply to you?

If you purchased a home prior to December 14, 2017, the good news is that certain of the old limits on mortgage interest deduction still apply to you. Purchase-money mortgages prior to that date retain the allowance for the deduction of interest on loans of up to $1 million if you are married filing jointly ($500,000 if single or filing separately). This so-called "acquisition" debt for your primary or secondary residence isn't subject to the new limits for purchases made in 2018.

Deductible mortgage amounts are lower for purchase-money mortgages (called "acquisition debt") taken after December 15, 2017; $750,000 (married filing jointly) or $375,000 (filing separately or single).

So, if you took a $900,000 mortgage in February 2016 and refinanced it in February 2018 in a straight rate-and-term refinance transaction, interest paid on the entire remaining balance of nearly $869,000 would still be eligible for the mortgage interest deduction, as the old limits for acquisition debt are carried forward.

From the IRS: Refinanced home acquisition debt. "Any secured debt you use to refinance home acquisition debt is treated as home acquisition debt. However, the new debt will qualify as home acquisition debt only up to the amount of the balance of the old mortgage principal just before the refinancing. Any additional debt not used to buy, build, or substantially improve a qualified home isn't home acquisition debt."

Just for reference, the IRS considers and improvement to be is "substantial" if it:

  • Adds to the value of your home,
  • Prolongs your home's useful life, or
  • Adapts your home to new uses.

Things can get more complicated if your existing loan amount was above the new limits and you did a cash-out refinance. Even if you took the proceeds and used them to "buy, build or substantially improve" the home against which the loan was taken, this would be considered a new acquisition loan, and would be subject to the new lower maximum loan limits. However, your original acquisition debt portion would be carried forward. Essentially, this new mortgage is treated as a brand-new loan and is subject to the new limits, with only the acquisition portion eligible for the tax deduction.

For example, you have $869,000 remaining on your existing mortgage and you do a cash-out refinance for $31,000 and renovate your basement. Even though it is used to improve your home, the new loan amount is above the new $750,000 threshold and only interest on the acquisition debt portion ($869,000) can be deducted. Interest on the other $31,000 would not be deductible, even though it was used to improve the home, because it is above the new or carried threshold.

In this case, it would be the same as if you did a cash-out refinance and used the proceeds for something other than "buy, build, improve" purposes as interest on the amount above the original acquisition debt isn't deductible. As with the example above, let's say you refinanced the $869,000 and took an additional $31,000 in equity out of the property to pay off some credit card bills. Only interest on the $869,000 would remain eligible for the mortgage interest deduction; the remaining $31,000 would not.

However, if you are below the $750,000 limit -- say, with a $600,000 loan amount -- and then pull out $100,000 in equity to improve your home -- your new total loan would be below the $750,000 limit and all the interest you pay would be tax deductible. Conversely, if you pulled out $100,000 to pay off credit card debt and buy a car, only the acquisition portion ($600,000) would remain eligible for the itemized tax deduction.

An example from the IRS:

"Example 1: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000. In February 2018, the taxpayer takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total does not exceed the cost of the home. Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible. However, if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan would not be deductible."

For reporting purposes, which is which, and who provides proof?

While your lender or servicer will provide you with Form 1098 (mortgage interest you paid), the existing form provides no breakout for interest that is considered acquisition debt (and is deductible) and that which isn't considered acquisition debt (and isn't deductible). This means you are responsible for figuring out which is and which isn't, so you'll need to closely track (and keep good records) of how you used proceeds from your cash-out refinance. Tracking the loan's principal amounts separately in a spreadsheet may help you keep things straight, and an amortization calculator can help you here, too.

Here's an interactive worksheet we located that may also help you to figure out your interest deductibility: Mortgage Interest Deduction Worksheet.

Note: The "grandfathered" debt referred to in the document deals with mortgages originated before 1987. As this was now 31 tax years ago, unless a loan written back then had an original term in excess of 30 years, this doesn't likely apply to too many folks. Even if you did, much of your payments would be comprised of principal with little actual interest paid, so you would likely use the standard deduction instead.

Do I get to write-off private mortgage insurance premiums as I did in other tax years, including 2017?

Probably not. Congress originally allowed homeowners to deduct mortgage insurance as part of the Mortgage Forgiveness Debt Relief Act of 2007. The law was extended several times through 2017, but effective December 31, 2017, the tax deduction for mortgage insurance expired.

According to the official IRS page:

"Mortgage insurance premiums. The itemized deduction for mortgage insurance premiums expired on December 31, 2017. At the time this Publication [936] went to print, Congress was considering legislation to extend the itemized deduction for mortgage insurance premiums." As well, from the IRS' instructions page for Schedule 1040A, where you would itemize such costs to deduct them, the document currently states "...the deduction for mortgage insurance premiums expired. You can't claim a deduction for amounts paid or accrued after 2017."

Should Congress retroactively authorizes the deductibility for PMI or MIP, you can file an amended return, if it is worth it in your situation.

Don't: Raise red flags by erroneously claiming points and fees from your refinance

"People often make the mistake of thinking that the points and fees paid on a refinance are tax deductible just as they may have been when they originally obtained the mortgage on their home," says Jones. "That, however, is not the case."

Jones explains that, per IRS guidelines, points paid when refinancing are not taken in full during the year in which the refinance was obtained. "Instead, the points must be deducted equally over the life of the loan," she says. "To figure the annual deduction amount, divide the total points paid by the number of payments to be made over the life of the loan. Usually, this information is available from the lender."

For example, a homeowner who paid $2,000 in points on a 30-year mortgage (360 monthly payments) could deduct $5.56 per payment, or a total of $66.72 for 12 payments. Taxpayers may deduct points only for those payments actually made in the tax year, according to Jones.

Note: If your 2017 refinance was a second (or more) refinance, the undeducted portion of any points that were to spread among the old loan's remaining term are accelerated into the current year, and so the remainder of those undeducted costs become be fully deductible this year. Of course, any new points paid for the new mortgage will again be spread out over the new loan's term, as before.

Spreading the points paid over the life of the loan isn't the only factor determining whether or not your refinance expenses are fully tax deductible. You also have to take into account whether your original loan was before or after October 1987 (if you incurred mortgage debt prior to Oct. 14, 1987, different rules concerning tax deductibility may apply), whether or not your total combined mortgages exceed the allowable limit for the mortgage interest deduction, and whether or not portions of the refinance were used for home improvement, Jones says. "That last factor can sometimes enable you to write off more expenses during the year of the refinance," she notes.

If you're a homeowner, you certainly should take advantage of every homeownership tax deduction for which you qualify. But to make sure you don't run afoul of IRS tax rules, be sure to consult an accountant or financial advisor regarding your particular situation.

It's also a good idea, Jones suggest, to read IRS Publication 936 where all the nuances concerning the tax deductibility of mortgage refinance expenses are fully explained. "It's not necessarily in 'plain English,' but it's explained nonetheless," Jones says.

Related links:

Keith Gumbinger revised and updated this article.

Connect with Lenders
Connect with Lenders
Find Our Best Mortgage Rates
I need a loan for:
No Comments
Leave a Comment