Serial refinancers: Beware tax pitfalls on points
By Kay
Bell • Bankrate.com
If historically low mortgage rates turned you into
a serial refinancer, beware of the tax pitfalls surrounding the deductibility
of any points you paid on your new loan (or loans).
As a veteran homeowner, you're already well acquainted
with your house's many tax breaks. You've claimed mortgage interest
and property tax deductions for years. And when you refinanced the
first time, you were wise enough to know that the interest on the
new loan, although thankfully much less, still could help reduce
your Internal Revenue Service bill.
Heck, you even knew how to make tax use of the new
points
you paid. In most cases, points paid on a refinanced mortgage must
be deducted over the life of the loan. It's not quite as good a
tax deal as the immediate deduction for points you got on your original
mortgage, but it still offers some savings.
Once, however, was not enough. You diligently followed
mortgage rates (on Bankrate, of course) and were able to refinance
again at an even lower rate. Even better, the new refi is with the
same lender with whom you got your earlier refi. And because of
your prior lending relationship, you saved on the subsequent refi's
closing costs.
But by doing so, you've sacrificed an immediate tax
break when it comes to deducting points. (See Refinancing
and tax deductions table at the end of this story.)
Special refi point rules
Each point is 1 percent of the loan amount. Lenders charge points
as a way to make a profit and borrowers pay points in exchange for
lower mortgage rates.
When you pay points on your first mortgage, you're
generally able to deduct them on your tax return for the year in
which you took out the loan. Points associated with refinanced mortgages
(or equity loans or lines of credit) also can shave tax bills for
most folks.
In refi cases, however, any points usually must be
amortized over the life of the new loan. The main exception to this
rule is when you get extra cash from a refi to make improvements
to your home. In this case, you can deduct the points attributable
to this improvement money all at once. But the portion of the points
related to the refinanced existing balance are not eligible for
immediate tax-deduction purposes; they must be amortized over the
life of the refinanced loan.
Mark H. Misselbeck, CPA with Levine
Katz Nannis & Solomon PC in Needham, Mass., gives this example:
You have existing home debt of $200,000 and refinance
to $250,000 so you can put a $50,000 addition on the house. You
pay 1 point ($2,500) for the refinanced loan. Since $500 in points
is attributable to the amount you will use for the home improvement,
that $500 is immediately deductible on your taxes. The remaining
$2,000 in points is considered prepaid interest that must be amortized
over the life of the $250,000 loan.
"Only if the loan proceeds from the refinance
were totally used to purchase the principal residence or improve
the principal residence would all of any points paid on a refinance
be fully deductible," notes Misselbeck. "This would usually
not be the case, since the whole point of a refinance is to lower
the cost of existing debt, not take out a totally 'fresh' amount
of money, except in unusual circumstances, to improve a principal
residence."
But in many cases, homeowners use cash-out refi or
home equity money for something other than home improvement, such
as paying college costs or buying a car. Here they still can deduct
the points paid on these loans, but not completely on one tax return.
They must parcel out the point deductions in each tax year over
the equity loan's term.
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. For example, if you paid $1,500 in points on a
30-year refi (360 monthly payments), you can deduct $4.17 per payment,
or a total of $50 a year, for each tax year of the loan.
Serial refinancing restrictions
What if the continuing interest rate drops prompted you to refinance
again? The good news for most homeowners is that they don't lose
that portion of the first refi's points that they've been amortizing.
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