Understanding Refinance Mortgage Tax Deductions in 2023
One of the benefits of home refinancing has always been the tax deductions of a mortgage refinance and the closing costs incurred during the transaction. Most people who buy a home or refinance an existing mortgage pay closing costs. So, you may wonder if you can tax deduct some of your closing costs on a refinance mortgage in 2023. The good news is you can deduct some of these costs on your taxes on your refinance mortgage!
Some of the closing costs you can tax deduct on a refinance mortgage in the year you pay them are:
- Points paid on a cash-out refinance for home improvements. If you do a cash-out refinance to lower your interest rate and pull-out cash, the refinance points may be deductible on your taxes. However, you must prove that the cash was used for capital improvements on the home, not simply home repairs. If you use the cash for another purpose besides capital improvements, you cannot deduct the points.
- FHA mortgage insurance and VA funding costs: Loans that are backed by the US government such as FHA and VA loans usually reduce the risk of the loans by charging you mortgage insurance or funding fees. You may be able to tax deduct upfront mortgage insurance premiums and mortgage insurance premiums paid on a loan backed by FHA.
- Funding fees you pay for a refinance loan backed by the VA.
- Guarantee fees charged for a refinance loan backed by the USDA.
Note: If you are using some of the refinance money for a purpose other than a home improvement, any additional points you paid can be deducted throughout the rest of the loan term.
If you have questions about the tax deductions you can take when you do a refinance loan, please talk to your tax advisor.
What Closing Costs Can Homeowners on a Cash Out Refinance Loan Deduct in 2023?
Taking out a mortgage always includes closing costs that can run into the thousands of dollars. But the good news is you may be able to deduct some of your closing costs on a cash-out refinance loan in 2023.
The biggest thing you can tax deduct when you do a cash-out refinance loan are mortgage points. If you paid for points when you did your refi, you might be able to deduct them on that year’s taxes.
Mortgage points are prepaid interest and you pay them upfront to enjoy a lower interest rate when you repay the loan. One point is 1% of the loan amount. So if you are paying 2 points on a $100,000 refinance, you may be able to deduct $2,000 from your income on your next tax return.
However, you may need to deduct the points paid on your refinance over the life of the loan, so talk to your tax advisor on this.
Also remember that you can usually only deduct points on a cash-out refinance if you use the money for capital improvements on the home.
For example, if you take out $25,000 in equity to pay for a kitchen remodel and paid $1,000 in points, you should be able to deduct the $1,000 off your income on your next tax bill.
However, if you used the $25,000 to pay for college tuition, the tax deduction doesn’t apply. The tax deduction also doesn’t apply if the money is used for simple home repairs, such as repairing the HVAC system.
Make sure the money is being used for capital improvements, then you can probably deduct the points off your taxes. Find out how much closing costs are if you refinance your home.
How to Qualify for Mortgage Interest Tax Deduction on A Cash-Out Refinance in 2023
If home renovations are on your mind, you might be considering a cash-out refinance loan to pull out some equity. Many homeowners use a cash-out refinance to pay for home remodeling, which may add value to the home when you sell.
However, there were changes to federal tax laws in 2017 with the Tax Cuts and Jobs Act that you should know about that may affect your tax deductions related to pulling out equity.
First, note that when you take the equity out with the refi, the IRS doesn’t consider it income; they view it as another home loan. So, you don’t need to include the equity as part of your income when you file your taxes.
However, in exchange for this benefit, there are new rules on what you can and can’t deduct when you pull out the equity. While you can use the money for anything you wish, you will need to use the money for home improvements to deduct the loan interest on your taxes.
The IRS states that you need to make some type of home improvement that boosts the value of the home to deduct the interest. The new tax law states you cannot deduct the loan interest if the money is used for anything else.
In the past, you could still deduct the interest if you used the equity to pay off credit cards or go on vacation.
Keep in mind that you need to make capital improvements to the home that increase the value to qualify for the tax deduction.
A basic home repair isn’t a capital improvement. So, for example, repairing the central AC isn’t a capital improvement, but upgrading the AC system to a more energy-efficient model is.
Mortgage refinance closing costs can be a substantial financial burden, but for many homeowners, there is a silver lining—tax deductions. While not all closing costs are eligible for tax benefits, understanding which ones are can potentially save you money in the long run.
Firstly, it’s crucial to recognize that the tax laws regarding mortgage-related deductions can change, so it’s advisable to consult with a tax professional or refer to the latest tax guidelines. As of my last knowledge update in September 2023, here are some common mortgage refinance closing costs that may be tax deductible:
- Points or Loan Origination Fees:
– In a home refinance transaction, some people choose to pay points to lower the interest rate. Each point is equal to 1% of your loan amount. Yes, points can be tax-deductible in the year they are paid, but the deduction might be spread over the life of the refinance mortgage.
- Prepaid Interest:
– The interest you pay at closing for the period between the closing date and the end of the month is considered prepaid interest. This amount is tax-deductible in most cases.
- Property Taxes:
– Property taxes are one of the most common closing costs. If you paid property taxes at closing, they are tax-deductible in most instances. However, property tax deductions are subject to certain limits and conditions and may vary by, county, state, city, etc.
- Mortgage Insurance Premiums:
– If you are required to pay private mortgage insurance (PMI) or mortgage insurance premiums (MIP), these may be deductible depending on your income and other criteria. Note that this PMI tax-deduction might not last forever and has been subject to Congress passing extensions.
- Home Equity Loan Interest:
– If a portion of your refinance was used to make home improvements, the interest on that portion might be deductible. However, the Tax Cuts and Jobs Act of 2017 limited the tax-deductibility of home equity loan interest.
- Loan Application Fees:
– Some lending closing costs, such as appraisal fees, underwriting fees or application fees may be deductible. However, it’s essential to distinguish between one-time fees and ongoing expenses.
It’s recommended to keep detailed records of all your closing costs and consult with a tax attorney or experienced accountant to ensure compliance with current tax laws for 2023. Additionally, mortgage tax deductions often depend on various factors, including your financial situation, the purpose of the refinance, and the use of the mortgage proceeds.
While these mortgage refinance deductions could provide financial relief, it’s important not to let the potential tax benefits be the driving force to refinance your home. If you choose to refinance your existing mortgage you should make that commitment because you are saving money from interest rate savings, reduced mortgage terms, and of course, you should always consider the cost carefully before signing a contract of this magnitude.
In conclusion, mortgage refinance closing costs can provide tax benefits that offer some financial relief. We always suggest that you seek wise counsel with a tax professional so that you can make a prudent decision that meet with your financial goals now and in the future.
Talk to your tax advisor if you have questions about qualifying for the interest deduction when you do your mortgage refinance.