Home Refinance Tax Deductions

The IRS allows interest deductions after you refinance a mortgage.

The Internal Revenue Service encourages taxpayers to purchase homes by allowing the deduction of annual mortgage interest payments. Refinanced mortgages receive the same tax treatment as first mortgages provided you meet all requirements. Taxpayers must become familiar with the rules specific to refinanced mortgages before taking the deduction.

Deduction Eligibility

To deduct the interest on a second mortgage you must file a Form 1040 with itemized deductions, be legally liable for the loan, and have a true debtor-creditor relationship with the mortgage lender. The mortgage interest deduction starts phasing out for taxpayers with an adjusted gross income in excess of the proscribed amount. As of 2009 for example, the deduction phase-out affected taxpayers with an adjusted gross income above $166,800.

Secured by Home

If you refinance an original mortgage, the interest on the second mortgage is tax deductible if you secure the loan by the mortgaged home. You meet this requirement if the mortgage document states that the taxpayer's ownership interest in the home is security for payment of the debt, and in the event of default, the home will satisfy the debt. A second mortgage secured by other taxpayer-owned homes will not meet the security requirement.

Qualified Home

Interest paid on a refinanced mortgage is deductible on the main home plus one additional home. If you have more than one second home, you can choose any one of them for the mortgage interest deduction. The residence you choose as a second home for purposes of the deduction is not binding beyond the current tax year. You can pick a different home each tax year.

Limitations

The IRS limits the deduction to interest that accrues on a maximum of $1 million in aggregate principal balances for all home mortgages that qualify for the deduction. An eligible refinanced mortgage cannot exceed the outstanding principal balance that existed on the first mortgage immediately before refinancing. The IRS will disregard additional amounts borrowed for the interest deduction.

Points

Unlike the points paid on a first mortgage, points you pay to refinance a mortgage are not fully deductible in the year paid. You must deduct the points in equal annual installments over the life of the mortgage.

Reductions

There may be a reduced amount of deductible interest on a second mortgage if the home is not solely a personal residence of the taxpayer. If you have a separate unit in the home you regularly rent out, you must allocate annual mortgage interest payments between the personal and rental use. Only the amount allocated to personal use can be an itemized deduction. You must do the same allocation if you use a portion of the home predominantly for business purposes.

References

• IRS Publication 936: Home Mortgage Interest Deduction