Mortgage

How a mortgage refinance may have an effect on your taxes

Does Refinancing Affect Taxes?

Unfortunately, there is no blanket answer here. Refinance may or may not affect your taxes, depending on what type of refinance you used and how you file it.

Typically, your mortgage doesn't affect your taxes unless you list your deductions.

And if you used simple rate-and-term refinancing, there's likely no tax implications. A payout refinance might have some, but you don't have to pay income tax on the equity paid out. Here's what you should know.

The Mortgage Reports is not a tax site. This information is for general guidance only. Let a tax advisor advise you on your specific situation.

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Note on mortgage tax deductions

Refinancing loans are treated like other mortgage loans for tax purposes. You may be able to deduct certain expenses such as mortgage interest, but only if you list your deductions. If you take the standard deduction (which most applicants do), your mortgage refinancing won't affect your taxes one way or another.

According to the Tax Policy Center, only 31% of US taxpayers itemized their deductions in 2017. And even fewer did so in 2018 after new tax laws. The website smartasset calculates: "In 2017, 47.1 million taxpayers reported itemized deductions, compared to 15.3 million in 2018."

So does refinancing affect taxes? Only for a relatively small number of taxpayers. And usually just a little.

Cash-out Refinancing Tax Impact

Let's start by clearing up a common misconception. You pay no taxes on the amount borrowed with a cash-out refinancing. The Internal Revenue Service (IRS) considers the money from your refinance to be a loan and not taxable income. So you pay no income tax on it.

You don't pay income tax when you take out a loan to buy a car or sign up for other types of loans because the value you receive isn't income. It must be paid back with interest. And the same goes for a cash-out refinance.

For the full story you should download and read Release 936 — home mortgage interest Deduction from IRS website and check for updates here.

But here's a broad overview of the tax rules that typically apply to payout refinances for those who list deductions.

Deduction of mortgage interest

Before the Tax Reduction and Employment Act of 2017, you could basically deduct all mortgage interest. But this law changed the situation for many mortgage-related deductions.

If you use the proceeds of your cash-out refinance for something other than home improvement, you won't be able to deduct the interest on that portion of your mortgage.

Eligible improvements include anything intended to increase the value of your home, such as: Think of an addition, a home in your backyard, energy efficiency improvements, a new HVAC system, or replacing your roof with something more permanent.

However, they do not include routine repairs and maintenance. So a whole new roof or HVAC system can add value to your home. But replacing some broken tiles or fixing your old air conditioner doesn't count.

Deduction for discount points

Some people pay extra at closing to buy a lower mortgage rate. When you do this, you buy "discount points". And you used to be able to deduct the full cost at the end of the tax year you bought it.

But now you have to deduct these points "pro rata" (in equal installments) over the life of your loan. So if you have a 30-year loan, subtract one-thirtieth of the cost each year. With a 15-year loan, you deduct one-fifteenth of the cost each year.

home office

If you own your own business or partner up and build an extension to your home that will be used solely as a home office, you may be able to claim mortgage interest and other deductions.

There are some rules. So check out the full details on the IRS website.

rental item

If you as a landlord refinance a rental property, completely different rules apply. You can usually deduct a wider range of expenses, including renovation work, Closing costs, interest and insurance, which Rocket Mortgage says you pay out of your income as business expenses.

Impact on Interest and Term Refinancing Taxes

It is unlikely that there will be any tax implications as a result of interest rate and term refinancing. (This is any refinance that doesn't give you cash back on closing.)

You still can't deduct your closing costs. But you should be able to deduct all of your mortgage interest (if you file your taxes) because you haven't borrowed more money.

If you choose to buy rebate points, the same rules apply as cash-out refinances: you withdraw them annually over the life of your mortgage, according to intuit, the company behind Turbotax.

Effects on the second mortgage tax

Let's say you decide to get a second mortgage (a home equity loan or line of credit (HELOC)) instead of a payout refinance. Can you still deduct mortgage interest?

Again, it depends on what you use the funds for. If you're buying a home or significantly improving it, you probably can. But if you're borrowing for other purposes (doctor's bills, vacation, wedding… whatever) you almost certainly won't.

The IRS Release 936 — home mortgage interest deduction gives full details.

Will Refinancing Increase My Property Taxes?

No, refinancing doesn't have a direct impact on your property taxes—even if you get a new, higher estimate when you refinance. That's because your property taxes are assessed by your local tax authority based on their own estimate of the value of your home. This is not affected by your mortgage assessor's rating.

However, if the lender's appraisal shows that your home is worth a lot more than your tax authority thinks, it may be a sign that you live in a place with rapidly rising home prices. So you could expect a property tax increase next year. But that is solely due to house price inflation.

Which refinancing costs are tax deductible?

Unless you're a landlord refinancing a rental property, you typically can't deduct any of your closing costs. The only exception is optional discount points, which are purchased to buy down your plan.

And these days, you can't deduct all of those points at the end of the tax year when you refinance. Instead, you can deduct them annually over the life of your loan. So you can deduct one-thirtieth of the cost each year if you have a 30-year mortgage. And a fifteenth if you have a 15 year old.

Again, this only applies if you list your tax deductions (not if you take the standard deduction).

How much mortgage interest is tax deductible?

You can deduct all of your mortgage interest if you used the loan to buy your home or significantly improve your home. Such improvements must add value.

However, you cannot deduct mortgage interest on portions of your loan that you have used for other purposes.

So if you received a payout refinance and spent the money on debt consolidation, starting a business, financing a wedding or vacation, or any other purpose that doesn't involve home improvement, you won't be able to deduct that interest.

Bottom Line: Does Refinancing Affect Taxes?

This brings us back to our original, fundamental question: Does refinancing affect taxes?

It is highly unlikely to have any impact if you only do interest rate and term refinancing. And for most, the impact of a cash-out refinance will likely be small.

The biggest thing about withdrawing cash is that you can't deduct interest on the extra amount you borrowed — unless you spent it on renovations that added value to that home.

The Mortgage Reports is not a tax site. This information is for general guidance only. Let a tax advisor advise you on your specific situation.

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