Can I Write Off Points On A Refinance? Your Guide to Tax Deductibility
Refinancing your mortgage can be a smart financial move, potentially lowering your interest rate and monthly payments. But beyond the immediate benefits, a common question pops up: Can you write off the points you pay when refinancing? The answer, like many tax-related questions, isn’t always straightforward. This article will break down the complexities surrounding deducting points on a refinance, exploring the rules, regulations, and crucial factors to consider.
Understanding Mortgage Points: What Are They, Really?
Before diving into deductibility, let’s clarify what mortgage points actually are. Points, sometimes referred to as discount points, are fees you pay upfront to your lender in exchange for a lower interest rate on your mortgage. One point equals 1% of the loan amount. For instance, if you’re refinancing a $300,000 mortgage and pay one point, you’ll pay $3,000 upfront. The trade-off is a lower interest rate over the life of your loan, potentially saving you a significant amount of money in the long run.
The General Rule: Points on a Refinance Are Usually Not Fully Deductible in the Year You Pay Them
Here’s the core of the issue. Unlike points paid on the original purchase of a home, points paid on a refinance typically aren’t fully deductible in the year you pay them. Instead, you generally have to amortize, or deduct, them over the life of the loan. This means you deduct a portion of the points each year. The IRS views refinancing points differently because they aren’t considered a direct cost of acquiring the home, but rather a cost of obtaining new financing.
Amortization: Spreading Out Your Deductions Over Time
So, how does amortization work in practice? Let’s say you refinance a $250,000 mortgage and pay $5,000 in points (two points). You’re taking out a 30-year loan. To figure out your annual deduction, you would divide the total points ($5,000) by the loan term in years (30). This results in an annual deduction of approximately $166.67.
Exceptions to the Rule: When You Can Deduct Refinance Points Immediately
While amortization is the standard, there are specific situations where you might be able to deduct the remaining points from a refinance in the year you pay them. These situations often involve the loan being refinanced.
Refinancing with the Same Lender
If you refinance with the same lender, and the refinancing does not result in your original loan being paid off (e.g. the new loan is a modification of the existing loan), you cannot deduct the points immediately. The points would still need to be amortized over the life of the loan.
Using Refinance Proceeds to Improve Your Home
When you use the refinance proceeds to make substantial improvements to your home, you might be able to deduct the points immediately. However, the improvements must be a direct result of the refinance and the improvements must be considered capital improvements, not maintenance or repairs. Carefully document all improvements and keep detailed records. This is a complex area, and consulting with a tax professional is highly recommended.
Paying Off the Refinanced Loan Early
If you pay off your refinanced mortgage before the end of the loan term (perhaps by selling your home or refinancing again), you can deduct any remaining, unamortized points in the year the loan is paid off. This is because the IRS recognizes that you’ve effectively paid the entire cost of the points and are no longer benefiting from the lower interest rate over the full loan term.
Documenting Your Points and Deductions: Essential Record Keeping
Proper documentation is critical when claiming any tax deduction, especially when dealing with something as nuanced as mortgage points. Keep the following documents organized and readily accessible:
- Loan Application and Closing Documents: These documents will detail the amount of points you paid, the loan amount, and the loan term.
- Form 1098 (Mortgage Interest Statement): Your lender will send you this form each year, which includes the amount of mortgage interest you paid, as well as any points paid during the year.
- Records of Any Home Improvements: If you’re claiming a deduction based on using refinance proceeds for improvements, maintain detailed records of the work done, the costs incurred, and any related receipts.
- Amortization Schedule: Create a simple amortization schedule to track the annual deduction. This is especially helpful if you plan on paying off the loan early.
Understanding the Impact of Tax Reform on Mortgage Interest Deductions
Tax laws can change, and these changes can impact your deductions. For example, the Tax Cuts and Jobs Act of 2017 made significant changes to itemized deductions, including the deduction for home mortgage interest. While the rules for deducting points generally remained the same, the overall impact of the tax law changes might affect whether you itemize at all. Consult with a tax advisor to understand how current tax laws apply to your specific financial situation.
The Importance of Seeking Professional Tax Advice
Navigating the complexities of deducting points on a refinance can be overwhelming. The IRS has specific rules, and interpretations can vary. Therefore, it’s highly recommended to consult with a qualified tax professional (like a Certified Public Accountant or CPA) or a tax advisor. They can provide personalized guidance based on your individual circumstances, ensuring you accurately report your deductions and avoid potential penalties.
Frequently Asked Questions (FAQs)
What about paying points on a home equity loan? Points paid on a home equity loan are generally treated the same as points on a refinance: amortized over the life of the loan unless specific exceptions apply.
Can I deduct points if I use the standard deduction? No, you can only deduct points if you itemize deductions on Schedule A of Form 1040. If your itemized deductions don’t exceed the standard deduction amount, you can’t claim the points deduction.
Do I need to recalculate my deduction if I refinance again? Yes, if you refinance again before the original loan term is complete, you’ll need to recalculate the remaining unamortized points and determine how to deduct them. This is often done in the year of the second refinance.
What if I didn’t receive a 1098 form? If you don’t receive a 1098 from your lender, contact them immediately. It is your responsibility to obtain this form. If you can’t get it, you will need the closing documents and other loan information to determine the amount of points paid.
Is there a limit on the amount of mortgage interest I can deduct? Yes, there are limits. The amount of mortgage interest you can deduct is limited by the amount of the loan. The limits can change, so consulting with a tax professional is important.
Conclusion: Making Informed Decisions About Refinance Points
In conclusion, the deductibility of points on a refinance is a complex topic. While you can’t typically deduct the full amount in the year you pay them, understanding the amortization rules and the exceptions is crucial. Keep meticulous records, consider the impact of tax reform, and, most importantly, seek professional tax advice. By taking these steps, you can make informed decisions, accurately report your deductions, and maximize your tax benefits. Refinancing can be beneficial, but understanding the tax implications of points is a key part of making it a financially sound decision.