Now may be a great time to refinance, because mortgage rates are still low but expected to increase. Before deciding to refinance, however, here are a couple of tax consequences to consider:
1. Cash-out refinancing. If you borrow more than you need to cover your outstanding mortgage balance, the tax treatment of the cash-out portion depends on how you use the excess cash. If you use it for home improvements, it’s considered acquisition indebtedness, and the interest is deductible subject to a $1 million debt limit. If you use it for another purpose, such as buying a car or paying college tuition, it’s considered home equity debt, and deductible interest is subject to a debt limit. The debt limit is limited to the lesser of the actual loan balance, not to exceed $100,000 or the fair market value of the home minus the outstanding acquisition indebtedness. Although the interest would be deductible for regular tax purposes, it would not be deductible when calculating the alternative minimum tax (AMT).
2. Prepaying interest. “Points” paid when refinancing generally are amortized and deducted ratably over the life of the loan, rather than being immediately deductible. If you’re already amortizing points from a previous refinancing and you refinance with a new lender, you can deduct the unamortized balance in the year you refinance. But if you refinance with the same lender, you must add the unamortized points from the old loan to any points you pay on the new loan and then deduct the total over the life of the new loan.
Is your head spinning? Don’t worry; we can help you understand exactly what the tax consequences of refinancing will be for you. Contact us at 703.385.8888.
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