Owning a home is a tenet of the American dream, and an important facet of the nation’s economy. Homeownership has been shown to provide long-term financial stability, and is one of the primary ways that people build wealth.
That’s why the U.S. government encourages homeownership by offering tax deductions that make it more affordable for people to buy, own, and refinance a home. Many tax deductions for homeowners relate to mortgages — most notably the mortgage interest deduction.
If you own a home, you may be thinking about how mortgage refinancing could help your financial situation. And while you might be familiar with homeowner-related tax deductions, you may need some help answering this question: Are refinancing costs tax deductible?
The short answer is yes — but it can be complicated. So read on to learn which refinancing costs you may deduct from your income taxes, and how to do it:
- What Refinance Costs Are Tax Deductible?
- What Refinance Costs Are Not Tax Deductible?
- Tax Deductions When Refinancing a Rental Property
- How To Claim Your Refinance Costs on Your Taxes
- Additional Resources for Refinance Tax Deductions
- The Bottom Line on Tax Deductions for Refinancing Costs
What Refinance Costs Are Tax Deductible?
Most of what you can deduct from your taxes when you refinance a home is similar to what you can deduct with your original mortgage. There are some differences, though.
The mortgage interest deduction is the main benefit that most homeowners get from owning a home. In the early years of repaying a mortgage, most of their monthly payment goes toward interest. Deducting that from their income could save homeowners — especially new ones — up to thousands of dollars. To claim this benefit, homeowners must itemize instead of taking the standard tax deduction.
Generally, the same rules apply when you refinance. If you do a rate-and-term refinance — where the new loan amount is the same or less than the balance on your original mortgage — you can deduct all the interest paid, as long as the home is your primary residence or a second home you don’t rent out.
Different rules apply if you choose a cash-out refinance, and your new loan is larger than the remaining balance on your original mortgage. You can deduct all the interest due on the amount of the loan you are refinancing. But on any amount over that, you can only deduct the interest paid on the portion of that sum you use to make capital improvements on your home.
The IRS defines qualified improvements as permanent changes or additions that increase the home’s value, prolong its useful life, or adapt it to new uses. If you take out cash for other purposes — such as to consolidate debt or pay college tuition fees — you cannot deduct the interest paid on that amount.
For example, say your home is worth $250,000, and your current mortgage balance is $150,000. You refinance to a new loan for $200,000, repaying the old mortgage and pocketing the remaining $50,000. If you use all that cash to build an addition to your home, you can deduct the interest you pay on the entire $200,000 loan. If you use that cash to consolidate debts or pay college tuition, you can only deduct the interest you pay on $150,000 of the loan.
When you buy mortgage points, you are prepaying interest on your loan. Each point or fraction of a point that you pay reduces the interest rate on your loan.
As a form of prepaid interest, points can be deducted when you file your taxes. Typically, you must deduct the cost of points over the life of the loan. For example, if you paid $15,000 for points on a 30-year loan, you would be able to deduct $500 per year.
But if you take out cash and use that money to improve your home, you might be able to fully deduct the related points in the year you paid for them. The rest would be deducted over the life of the loan. This gets complicated, so consult a tax expert if you need help figuring it out.
If you pay property taxes, you can deduct that amount from your income when you file your taxes. Individuals can deduct up to $10,000 total in state and local taxes each year. The average homeowner pays just under $2,500 in property tax each year, so most people can take full advantage of this deduction.
What Refinance Costs Are Not Tax Deductible?
Refinancing your primary home means you have to pay closing costs, which in general are not tax deductible. Settlement fees aren’t tax deductible, either.
Getting a loan is an involved process that can require appraisals, credit checks, and lots of paperwork. You have to pay closing costs — which come out to an average of $5,000 for a refinance — before you can sign the paperwork and close on the deal.
For a primary residence, these costs are not tax deductible.
When you settle on a loan, you may have used a settlement agent or an escrow holder to hold a portion of the money involved in the transaction. Any fees paid to this agent are not tax deductible.
Tax Deductions When Refinancing a Rental Property
Are refinance closing costs tax deductible on rental property? The rules for rentals are a bit different compared with the rules for primary residences.
Unlike with your primary residence, settlement fees and closing costs are added to the value of the rental property, and become part of the depreciation deduction.
“Most rental property closing costs are tax deductible … and do not require an itemized return to be filed,” says Corey Tyner, founder of Buy Yo Dirt, a real estate investment firm based in Phoenix, Arizona.
Eligible costs include fees for abstracts, legal fees, recording fees, and title insurance, Tyner says.
This means those costs are deducted over the life of the loan. For example, if you refinance to a 30-year loan and pay $3,000 in closing costs, you can deduct $100 each year over the life of the loan.
As when you refinance your primary home, you can deduct eligible interest, points, and property taxes when you refinance a rental.
How To Claim Your Refinance Costs on Your Taxes
Few people enjoy preparing their taxes, but it pays to do them correctly. Taking care at tax time could help you save up to hundreds or thousands of dollars.
“To claim these deductions, homeowners need to fill out Schedule A with their Form 1040 tax return,” says Cliff Auerswald, president of All Reverse Mortgage, a reverse mortgage company based in Orange, California. “They can either itemize all their tax-deductible expenses on that form, or choose to go with a standard deduction.”
Additional Resources for Refinance Tax Deductions
The U.S. tax system is complicated. A valuable resource for understanding tax deductions related to homeownership and refinancing is the IRS itself.
IRS Publication 530 is all about tax information for homeowners, with the answers to if you can deduct closing costs on taxes, details on what closing costs are tax deductible in which scenarios, and what special tax programs are available to homeowners. There’s a lot of information, so make sure to go through it carefully in case you find a deduction that applies to your situation.
It’s always a good idea to consult a tax expert if you have questions about which deductions you can take, and how to correctly claim them.
The Bottom Line on Tax Deductions for Refinancing Costs
Refinancing your mortgage could be a great way to adjust the terms of your loan and help you save money. Now that you know what refinance costs are tax deductible, and the tax deductions you can take, you could end up saving even more money when refinancing.