As rates of interest plummeted all through 2020, mortgage refinancing turned a significant avenue to saving cash within the midst of the coronavirus pandemic. However those that took the plunge want to concentrate on how opting to refinance may have an effect on their taxes insofar as deductions are involved.
The Mortgage Bankers Affiliation estimated that lenders originated some 7.1 million refinance loans final yr. “The overwhelming majority of householders should not even going to qualify to take the tax deductions,” mentioned Holden Lewis, housing and mortgage professional at personal-finance web site NerdWallet.
The Tax Cuts and Jobs Act of 2017 in the end kept the mortgage interest deduction round, albeit with some adjustments, after some advised the GOP might resolve to jettison it.
However the Republican tax preform bundle did develop the usual deduction to $12,000 for particular person filers and $24,000 for joint returns. In increasing the usual deduction, Republican lawmakers created a excessive bar for itemizing deductions to make extra monetary sense for taxpayers.
And with rates of interest at present so low, most householders received’t be paying sufficient in curiosity every year for the deduction to be worthwhile, except they produce other deductions they will avail themselves of, consultants say.
In consequence, solely “a very small subset of householders” want to fret about how the mortgage curiosity deduction was modified,” Lewis mentioned.
How the mortgage curiosity deduction modified
The Tax Cuts and Jobs Act narrowed the quantity of mortgage debt on which the curiosity is deductible. Previous to the laws, householders may deduct curiosity on as much as $1 million in mortgage debt if the unique mortgage used to purchase, construct or enhance a house was originated between October 1987 and December 2017. (For loans on properties bought earlier than 1987, mortgage curiosity on the entire mortgage quantity could also be deductible, relying on eligibility.)
After the tax-reform bundle turned regulation, the mortgage curiosity deduction restrict was lowered. From 2017 onward, householders may solely deduct curiosity on as much as $750,000 in mortgage debt used to purchase, construct or enhance a house. Owners with pre-existing mortgages have been grandfathered in, which means they may nonetheless deduct up curiosity on as much as $1 million in mortgage debt in the event that they acquired the mortgage earlier than the 2017 cut-off.
From 2017 onward, householders may solely deduct curiosity on as much as $750,000 in mortgage debt.
So what does this all imply when you simply refinanced final yr? In case your new mortgage was smaller than $750,000, you’re seemingly within the clear. “In the event you simply refinanced the present steadiness [on the loan] at the moment and it was beneath $750,000, then you definately get the total curiosity deduction,” mentioned Ryan Losi, an authorized public account and government vp of Piascik, an accounting agency primarily based in Virginia.
And in case your unique mortgage was from earlier than 2017, you might be able to deduct the curiosity on as much as $1 million in debt. “For functions of figuring out which restrict applies (the older $1 million or the newer $750,000) the refinancing will typically relate again to the date of the unique mortgage for functions of the mortgage-interest deduction,” mentioned Tim Todd, an authorized public accountant and member of the American Institute of CPAs Monetary Literacy Fee.
How have been the mortgage proceeds used?
Many owners who used the low-rate alternative final yr to carry out a cash-out refinance — which means the principal on the brand new mortgage was bigger than the unique mortgage as a result of they took out a number of the built-up fairness.
But when somebody refinances greater than the unique mortgage, they’re topic to the brand new limits put in place by the 2017 regulation, Todd mentioned.
However even then, the added quantity might or might not be deductible. “Now it’s important to do the interest-tracing guidelines to say what these proceeds have been used for,” Losi mentioned.
The Inner Income Service states on its website that any further debt taken out via a refinancing that’s “not used to purchase, construct, or considerably enhance a professional residence isn’t residence acquisition debt.”
‘It’s important to do the interest-tracing guidelines to say what these proceeds have been used for.’
Let’s say the unique steadiness on the mortgage was $450,000, however the borrower refinanced and cashed out a further $50,000. They can deduct the curiosity on as much as $500,000 in that mortgage debt relying on how they used the cash they cashed out. In the event that they funded a house renovation, comparable to changing a bed room into an workplace, they’re within the clear. But when they used it to pay their youngster’s school tuition or purchase a brand new automotive, solely the unique steadiness might be eligible for the deduction.
Moreover, the IRS clarified that “the brand new debt will qualify as residence acquisition debt solely as much as the quantity of the steadiness of the previous mortgage principal simply earlier than the refinancing.” So if a home-owner cashes out via a refinance and places themselves above the $750,000 restrict in place now, the extra quantity might not be eligible.