How a mortgage refinance could affect your taxes

Does refinancing affect taxes?

Unfortunately, there’s no cut-and-dry answer here. Refinancing may or may not affect your taxes, depending on what type of refinance you used and how you file.

As a general rule, your mortgage only impacts your taxes if you itemize your deductions.

And, if you used a straightforward rate-and-term refinance, there likely aren’t any tax implications. A cash-out refinance could have some, but you will not have to pay income tax on the equity you cashed out. Here’s what you should know.

The Mortgage Reports is not a tax site. This information is for general guidance only. Consult with a tax professional about your specific situation.

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A note on mortgage tax deductions

Refinance loans are treated like other mortgage loans when it comes to your taxes. You may be able to deduct certain costs, like mortgage interest, but only if you itemize your deductions. If you take the standard deduction (which most filers do), then your mortgage refinance won’t affect your taxes one way or another.

Only 31% of U.S. taxpayers itemized their deductions in 2017, according to the Tax Policy Center. And even fewer did so in 2018, following new tax laws. The website smartasset reckons, “In 2017, 47.1 million taxpayers itemized deductions, relative to 15.3 million in 2018.”

So does refinancing affect taxes? Only for relatively few taxpayers. And typically only a bit.

Cash-out refinance tax implications

Let’s start by clearing up one common misconception. You don’t pay taxes on the amount you’ve borrowed using a cash-out refinance. The Internal Revenue Service (IRS) views the cash from your cash-out refinance as a loan rather than taxable income. So you won’t pay income tax on it.

You don’t pay income tax when you borrow to buy a car or when you sign up for other sorts of loans because the value you receive isn’t income. It has to be repaid with interest. And the same goes for a cash-out refinance.

For the full story, you should download and read Publication 936 — Home Mortgage Interest Deduction from the IRS’s website and check for updates here.

But here’s a broad overview of tax rules that commonly apply to cash-out refinances for those who itemize deductions.

Mortgage interest deduction

Before the Tax Cuts and Jobs Act of 2017, you could generally deduct all the interest on your mortgage. But that law changed the situation for many mortgage-related deductions.

If you use the proceeds of your cash-out refinance for anything other than home improvements, you cannot deduct the interest on that portion of your mortgage.

Eligible improvements include anything that should add to the value of your home, such as an addition, a residential accessory structure in your yard, energy efficiency improvements, a new HVAC system, or the replacement of your roof with something more durable.

But they don’t include routine repairs and maintenance. So a whole new roof or HVAC system might add value to your home. But replacing some broken tiles or fixing your old HVAC doesn’t count.

Deduction for discount points

Some people pay extra on closing to buy themselves a lower mortgage rate. If you do, you’re purchasing “discount points.” And you used to be able to deduct the full cost of those at the end of the tax year during which you bought them.

But now you must deduct those points “pro rata” (in equal installments) over the lifetime of your loan. So, if you have a 30-year loan, you’ll deduct 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 are in partnership and build an addition to your home that will be used solely as a home office, you may be able to make mortgage interest and other deductions. 

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

Rental property

If you’re a landlord refinancing a rental property, the rules are very different. You can normally deduct a broader range of costs, including home improvements, closing costs, interest, and insurance that you pay from your income as business expenses, according to Rocket Mortgage.

Rate-and-term refinance tax implications

There are unlikely to be tax implications as a result of a rate-and-term refinance. (This is any refinance where you don’t receive cash-back at closing.)

You still won’t be able to deduct your closing costs. But you should be able to deduct all your mortgage interest (if you itemize your taxes) because you haven’t borrowed more money.

If you choose to buy discount points, the rules are the same as those for cash-out refinances: you deduct them annually over the lifetime of your mortgage, according to intuit, the company behind turbotax.

Second mortgage tax implications 

Suppose you opt for a second mortgage (a home-equity loan or home equity line of credit (HELOC)) instead of a cash-out refinance. Are you still able to deduct mortgage interest?

Once again, that depends on what you use the funds for. If you buy or significantly improve a home, you probably can. But, if you borrow for other purposes (medical bills, vacation, wedding … whatever) you almost certainly won’t.

The IRS’s Publication 936 — Home Mortgage Interest Deduction gives full details.

Will refinancing make my property taxes go up? 

No, refinancing will not have a direct impact on your property taxes — even if you get a new, higher appraisal when you refinance. That’s because your property taxes are assessed by your local tax authority based on its own valuation of your home’s value. That won’t be swayed by your mortgage appraiser’s valuation.

However, if the lender’s appraisal shows that your home is worth much more than your tax authority thinks, that may be a sign that you’re living somewhere with rapidly rising property prices. So you may be in for a hike in property taxes next year. But that’s solely down to home price inflation.

What refinancing costs are tax deductible?

Unless you’re a landlord refinancing a rental property, you won’t normally get to deduct any of your closing costs. The only exception is for optional discount points purchased to buy down your rate.

And, nowadays, you can’t deduct all those points at the end of the tax year when you refinanced. Instead, you can deduct them annually over the lifetime of your loan. So you get to deduct one-thirtieth of the cost each year if you have a 30-year mortgage. And one-fifteenth if you have a 15-year one.

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

How much mortgage interest is tax-deductible?

You can deduct all your mortgage interest if you used the loan to purchase your home or substantially improve it. Any such improvements must increase its value.

But you won’t be able to deduct mortgage interest on any portion of your loan that you’ve used for other purposes.

So, if you got a cash-out refinance and spent the money on debt consolidation, starting a business, funding a wedding or vacation, or any other purpose that doesn’t involve home improvements, you won’t be able to deduct that interest.

The bottom line: Does refinancing affect taxes?

So, we’re back to our original, basic question: Does refinancing affect taxes?

It’s highly unlikely to have any impact if all you’re doing is a rate-and-term refinance. And, for most, the implications of a cash-out refinancing will probably be minor.

The biggest, if you’re taking cash out, is that you won’t be able to deduct interest on the extra sum you’ve borrowed — unless you’ve spent that on home improvements that have added to the value of that home.

The Mortgage Reports is not a tax site. This information is for general guidance only. Consult with a tax professional about your specific situation.

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