of Real-Estate Loan Refinancing Charges
By Steven V. Melnik
With interest rates at all-time lows, many
Americans are refinancing home loans. Because refinancing
transactions usually cost thousands of dollars, it is important
to know when refinancing expenditures are deductible.
Loans Secured by a Principal Residence
IRC defines a principal residence as where the taxpayer
spends the most time during any given taxable year. Consequently,
principal residence status can change from year to year.
As a general rule, taxpayers can deduct points paid for
refinancing principal residence loans.
section 461(g) defines many fees as points, but only qualifying
points are allowed as a deduction. Qualifying points are
usually fees paid to the lender for a loan (see the Sidebar
for a list of requirements). Loan application, processing,
underwriting, and other fees are not deductible.
Procedure 94-27 allows itemized deductions for qualifying
points resulting from the purchase of a principal residence.
Points paid for refinancing an existing mortgage, however,
cannot be immediately deducted. According to IRC section
461(g), those points are deducted over the life of the new
calculate the portion of those points deductible in any
particular year, determine the deductible points for each
loan payment and multiply by the number of payments made
during that year (per payment amortization). For example,
consider an individual who paid $1,800 refinancing qualifying
points on a principal residence for a 30-year loan requiring
12 payments per year (a total of 360 payments). The $5 allowable
deduction for every loan payment is calculated by dividing
$1,800 by 360. Six loan payments during the year would result
in a $30 itemized deduction, with unamortized points amounting
refinancing points are generally deductible in the year
when a second refinancing occurs with a different lender.
In the example above, the remaining $1,770 first-loan points
would be deductible that year. If the second refinancing
is with the same lender, however, the remaining points and
any new qualifying points paid would be deductible over
the life of the new loan.
paid during a refinancing transaction are immediately deductible
to the extent the new loan is used to substantially improve
a principal residence, assuming the requirements listed
in the Sidebar are met. Substantial improvements, such as
building an addition to a house, qualify. For example, a
$60,000 loan from bank B to refinance bank A’s $40,000
loan and a $20,000 house addition would result in one-third
of the newly paid qualifying points being deducted that
of Second or Vacation Homes
Americans are investing in real estate as an alternative
to stocks and bonds. Tax rules applicable to vacation and
second homes differ from those for primary residences. Points
paid for a purchase, substantial improvement, or refinancing
of second and vacation homes are generally deductible over
the life of the loan. The per-payment amortization method
is applicable. Other refinancing-related expenditures increase
the tax basis of the home.
Properties and Properties Used in a Trade or Business.
refinancing rental properties and properties used in a trade
or business, all ordinary and necessary refinancing expenditures
are deductible over the life of the loan. Refinance-related
expenditures for rental properties are deductible on line
18, Form 1040, Schedule E; for properties used in a trade
or business, expenditures are deducted on Form 1040, Schedule
sellers of real estate pay for points on the buyer’s
behalf, they are not allowed to deduct those points, but
can reduce sales proceeds. Buyers can deduct those points
if the property basis is reduced by the same amount.
other refinancing-related expenditures, such as attorney,
appraisal, bank, title, and other fees, are not deductible.
They do, however, increase the tax basis of the home to
the extent they are not deductible.
are deductible when a cash-basis taxpayer itemizes deductions.
Deductibility can be affected, however, when a taxpayer’s
adjusted gross income reaches a certain threshold. (The
2003 threshold is $69,750 for married filing separately
returns and $139,500 for all others.)
deductibility of refinancing-related expenditures depends
upon the type of property securing the refinanced loan,
as well as how the loan proceeds are used. The use of the
property must be understood, because properties can be used
for more than one tax purpose in any given year. It is important
to be familiar with the tax consequences of refinancing
transactions in order to derive the maximum benefit.
V. Melnik, LLM, JD, CPA, is Professor of Tax Law
and Director of Graduate Tax Programs at Bernard M. Baruch
College, City University of New York.