Is one of your New Year’s resolution to save money and do you own a home? Considering taking advantage of the current lowering trend in mortgage interest rates? How might a refinance affect your taxes with the tax law changes of the Tax Cut and Jobs Act (“TCJA”)?
Out with the Old
In general, until the implementation of the TCJA, for mortgages up to $1,000,000 ($500,000 for Married Filing Separately), the interest paid on the mortgage is deductible on your tax return. For mortgages greater than $1,000,000 ($500,000 for Married Filing Separately), only a percentage of the interest paid on the mortgage is tax deductible based on the specific calculation of each mortgage. Interest paid on a Home Equity Line of Credit (HELOC) could also be deductible up to a principal amount of $100,000 ($50,000 for Married Filing Separately).
In with the New
Under the new tax law, mortgage binding contracts entered into prior to 12/16/2017 (and the home purchased closed before 4/1/2018) are grandfathered in under the old tax rule. However, the TCJA makes a few changes for all mortgage binding contracts entered into on or after 12/16/2017. For these contracts, the mortgage interest paid is tax deductible for those mortgages up to $750,000 ($375,000 for Married Filing Separately). For mortgages greater than $750,000 ($375,000 for Married Filing Separately), only a percentage of the interest paid on the mortgage is tax deductible based on the specific calculation of each mortgage. For HELOCs, there are a few variables as to whether the interest paid is tax deductible; generally, the TCJA eliminates the HELOCs as being tax deductible.
Make a toast to Refinance
If you are not already feeling hungover about mortgage interest and the TCJA, the effect of refinancing your mortgage and how it can affect the tax deduction of the mortgage interest paid may create an even bigger headache. We need to consider whether the mortgage binding contract was incurred before or after the implementation of the TCJA and whether cash was taken out during the refinance.
First, we will uncork refinancing a mortgage that is considered grandfathered in under the TCJA and has a principal balance greater than the $750,000 limit ($375,000 for Married Filing Separately) and less than $1,000,000 limit ($500,000 for Married Filing Separately). If at the time of the refinance the principal balance of the new loan does not exceed the principal balance of the old loan – and is still considered home acquisition debt – then all the mortgage interest paid is tax deductible.
Cheer up, as the same holds true for those mortgage binding contracts entered into on or after 12/16/2017 under the TCJA and the principal balance is maintained at less than the $750,000 limit ($375,000 for Married Filing Separately). Otherwise, only a percentage of the mortgage interest paid is tax deductible based on the specific calculation of the new mortgage principal.
If you are thinking of taking cash out when refinancing, the tax deduction on this amount may be all but a memory. Any cash out on a refinance must be used to buy, build, or substantially improve a qualified home for the mortgage interest paid to be considered tax deductible. Additionally, any amount of the cash out that exceeds $750,000 ($375,000 for Married Filing Separately), is not considered tax deductible; regardless of whether the initial loan is grandfathered in or not.
A refinance may not be as promising as it seems. We recommend contacting your trusted advisor to take a renewed look at your tax position.