While interest rates are still low, you may be considering refinancing the mortgage on your principal residence or second residence to take advantage of low interest rates. You should beware of the following tax consequences:
- Cash-out refinancing used for improvements. When you refinance your existing mortgage, with no change in principal balance, the interest on the new mortgage will be deducted the same as the old mortgage. If you refinance more than the outstanding principal balance on your mortgage, the treatment of the interest payments on the excess cash (increased mortgage), depends on the utilization of these proceeds. If used to improve your residence, the increased mortgage balance will be considered qualified acquisition indebtedness or home equity debt, to the extent that all of your qualifying acquisition indebtedness is less than $1,100,000. The full amount of the interest will be deductible for both regular and alternative minimum tax purposes. If your total acquisition indebtedness is greater than $1,100,000, then the interest on the excess indebtedness (over $1,100,000) will depend on how the money is used.
- Cash-out refinancing used for other purposes. If you use the excess cash for any other personal purpose (nonbusiness), such as buying a boat, it will be considered home equity debt to the extent that all of your home equity debt is less than $100,000. The interest on your home equity debt will be deductible for regular tax purposes, but will NOT be deductible for alternative minimum tax purposes. If your total home equity debt exceeds $100,000, than the excess will be considered nondeductible personal interest. However, if the excess loan proceeds are used for investment purposes, the interest may be deductible as investment interest, subject to certain limitations.
Have questions about refinancing? Contact us!
Next week, I will discuss the tax consequences of refinancing with regards to prepaid interest with a new or existing lender.
Hal Zemel, a Tax Principal at Berdon LLP, has more than 20 years in public accounting and advises businesses in the real estate, service, and manufacturing sectors.