As interest rates have fallen throughout 2020, mortgage refinancing has become a major way to save money amid the coronavirus pandemic. But those who have taken the plunge should be aware of how choosing to refinance might affect their taxes when it comes to deductions.
The Mortgage Bankers Association estimated that lenders made some 7.1 million refinancing loans last year. “The vast majority of homeowners won’t even qualify for tax deductions,” said Holden Lewis, housing and mortgage specialist at personal finance website NerdWallet.
The 2017 Tax Cuts and Jobs Act retained the mortgage interest deduction around, but with a few changes, after some suggested the GOP might decide to dump it.
But the Republican tax preform package extended the standard deduction to $ 12,000 for individual filers and $ 24,000 for joint filers. By expanding the standard deduction, Republican lawmakers have created a high bar for itemizing deductions in order to make more financial sense for taxpayers.
And with interest rates currently so low, most homeowners won’t pay enough interest each year to make the deduction worth it, unless they have other deductions they can make use of. , say the experts.
As a result, only “a very small subset of homeowners” need to worry about how the mortgage interest deduction has changed, “Lewis said.
How the mortgage interest deduction has changed
The Tax Cuts and Jobs Act reduced the amount of mortgage debt on which interest is deductible. Before the law came into effect, homeowners could deduct interest on mortgage debt of up to $ 1 million if the original loan used to buy, build or improve a home was taken out between October 1987 and December 2017 (for loans on homes purchased before 1987, mortgage interest on the full loan amount may be deductible, depending on eligibility.)
After the entry into force of the tax reform package, the mortgage interest deduction ceiling was lowered. As of 2017, homeowners could only deduct interest on up to $ 750,000 mortgage debt used to buy, build or improve a home. Homeowners with pre-existing mortgages were grandfathered, meaning they could still deduct interest on mortgage debt of up to $ 1 million if they received the loan before the 2017 deadline.
So what does all of this mean if you just refinanced last year? If your new loan was less than $ 750,000, you’re probably in the clear. “If you have just refinanced the existing balance [on the loan] at that time and it was less than $ 750,000, then you get the full interest deduction, ”said Ryan Losi, a certified public accountant and executive vice president of Piascik, a Virginia-based accounting firm.
And if your original mortgage was before 2017, you may be able to deduct interest on debt of up to $ 1 million. “For the purpose of knowing which limit applies (the old $ 1 million or the most recent $ 750,000), the refinancing will generally be tied to the date of the original loan for the purposes of mortgage interest deduction,” said Tim Todd, chartered public accountant and member of the American Institute of CPA Financial Literacy Commission.
How was the loan proceeds used?
Many homeowners who took the low-rate opportunity last year to refinance in cash – meaning the principal of the new loan was higher than the original mortgage because they took a portion of accumulated net worth.
But if someone refinances more than the original loan, they’re subject to the new limits put in place by the 2017 law, Todd said.
But even then, the added amount may or may not be deductible. “Now you have to apply the interest research rules to tell what these products were used for,” Losi said.
Internal Revenue Service declares on its website that any additional debt incurred through refinancing that “is not used to purchase, build or substantially improve a qualifying home is not home acquisition debt”.
Let’s say the original mortgage balance was $ 450,000, but the borrower refinanced and cashed out an additional $ 50,000. They may be able to deduct interest on up to $ 500,000 from that mortgage debt depending on how they used the money they cashed out. If they’ve funded a home renovation, like converting a bedroom into an office, they’re in the clear. But if they used it to pay their child’s school fees or buy a new car, only the original balance will be eligible for the deduction.
In addition, the IRS clarified that “the new debt will only qualify as home acquisition debt up to the amount of the old mortgage balance just before refinancing.” So if a homeowner cash in on a refinance and places himself above the limit of $ 750,000 in place now, the additional amount may not qualify.