How does a refinance in 2011 affect your taxes?
Being a homeowner offers big tax advantages, not the least of which are perks related to that mortgage you pay every month.
And if you refinanced your mortgage last year, there are some specific "dos" and "don'ts" you need to know prior to filing your income taxes, as well as a few pointers that can help you lower your tax bite.
The following information will help to reduce your federal income taxes and get you prepared for mortgage-related tax issues in 2012 and beyond.
Do: Itemize to claim your mortgage interest deduction
As long as you itemize deductions on Schedule A (Form 1040), you can typically deduct up to $1 million in interest ($500,000 if you're married, filing separately) that you pay on a home loan for your primary residence, including your refinanced mortgage. Interest paid on a home equity loan is generally deductible up to $100,000.The mortgage interest deduction isn't available to those who take a standard deduction.
"When it comes to filing your tax return to reflect a refinance you did in 2011, the good news is that tax deductions for mortgage interest paid are still in place," says mortgage expert Debra Jones. "Will it remain that way in the future? Who knows? Although it is assumed that the mortgage interest deduction will remain intact, it has been a subject of much political and economic debate in this current presidential election season."
Indeed, several proposals floating around Congress would either reduce or eliminate the mortgage interest deduction for homeowners. If that happens in 2012 or later, you'll be especially glad that you claimed your deduction for 2011.
Do: Get a write-off for private mortgage insurance
Fortunately, if you refinanced in 2011, any qualified mortgage insurance premium payments made prior to 2012 can be deducted as long as you itemize, and provided the mortgage insurance contract was issued after 2006, according to a spokesman for the California Society of CPAs.
Just be aware of certain income restrictions because the deduction is phased out for those with adjusted gross incomes exceeding $100,000, or $50,000 for married couples filing separate federal income tax returns.
Also realize that 2011 looks like the last year you'll be able to write off mortgage insurance, at least for the foreseeable future.
Congress originally allowed homeowners to deduct mortgage insurance as part of the Mortgage Forgiveness Debt Relief Act of 2007. The law has been extended several times, including through 2011. But effective Jan. 1, 2012, the tax deduction for mortgage insurance expired, meaning homeowners can't claim this for tax year 2012 or later -- unless Congress retroactively amends the law.
Don't: Raise red flags by erroneously claiming points and fees from your refinance
"People often make the mistake of thinking that the points and fees paid on a refinance are tax deductible just as they may have been when they originally obtained the mortgage on their home," says Jones. "That, however, is not the case."
Jones explains that, per IRS guidelines, points paid when refinancing are not taken in full during the year in which the refinance was obtained. "Instead, the points must be deducted equally over the life of the loan," she says. "To figure the annual deduction amount, divide the total points paid by the number of payments to be made over the life of the loan. Usually, this information is available from the lender."
For example, a homeowner who paid $2,000 in points on a 30-year mortgage (360 monthly payments) could deduct $5.56 per payment, or a total of $66.72 for 12 payments. Taxpayers may deduct points only for those payments actually made in the tax year, according to Jones.
Spreading the points paid over the life of the loan isn't the only factor determining whether or not your refinance expenses are fully tax deductible. You also have to take into account whether your original loan was before or after October 1987 (if you incurred mortgage debt prior to Oct. 14, 1987, different rules concerning tax deductibility may apply), whether or not your total combined mortgages exceed the allowable limit for the mortgage interest deduction, and whether or not portions of the refinance were used for home improvement, Jones says. "That last factor can sometimes enable you to write off more expenses during the year of the refinance," she notes.
If you're a homeowner, you certainly should take advantage of every homeownership tax deduction for which you qualify. But to make sure you don't run afoul of IRS tax rules, be sure to consult an accountant or financial advisor regarding your particular situation.
It's also a good idea, Jones suggest, to read IRS Publication 936 where all the nuances concerning the tax deductibility of mortgage refinance expenses are fully explained. "It's not necessarily in 'plain English,' but it's explained nonetheless," Jones says.
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Lynnette Khalfani-Cox, The Money Coach®, is a personal finance expert, television and radio personality, and the author of numerous books, including the New York Times bestseller "Zero Debt: The Ultimate Guide to Financial Freedom." A former Wall Street Journal reporter for CNBC, Lynnette has appeared on such national TV programs as The Oprah Winfrey Show, Dr. Phil, The Today Show and Good Morning America. She can frequently be seen as a guest commentator on CNN, MSNBC, ABC and FOX Business Network. Follow Lynnette on Twitter @themoneycoach or visit her free financial advice blog at AskTheMoneyCoach.com.