The home mortgage interest deduction is one of the most potent tax breaks available to you today. The home mortgage interest deduction not only cuts the cost of home ownership, but it can also turn what normally would be a nondeductible expense into a legitimate deduction. Because the potential for tax savings is so great, you might find that a review of the rules is pertinent. As you will see, the rules are quite complex and full of both pitfalls and opportunities, because they depend on the taxpayer’s reason for getting a home mortgage or home equity loan.
For Home Buying
Like the vast majority of Americans, you usually can fully deduct the interest paid on a loan if the proceeds are used to buy or build a residence (a main home and one vacation home). This type of financing is called acquisition debt; it cannot exceed an aggregate of $1 million for all interest to be deductible and must be secured by your home. In most situations, you also will be able to fully deduct any points paid to the lender in the year you obtain a mortgage loan to buy your primary residence.
Maximizing the potential for tax savings is often a challenge. For example, suppose you are selling a home in which you have substantial equity and buying another home. Is it better to use all of the cash you net on the sale as a down payment and obtain a small mortgage and small deductions on the new home? Or should you invest the cash elsewhere, possibly in a tax-favored vehicle and obtain a larger mortgage that yields fully deductible interest?
For Home Remodeling
If you refinance your existing loan to pay for an expansion or remodeling of your home, all of the interest you pay on the new loan usually will be deductible as acquisition debt. Here, the decision-making process often involves financial as well as tax considerations. Are you better off refinancing your existing loan, getting a second mortgage or a home equity loan? How many points will you pay on the new loan? Will you pay for the points at the loan closing, or will you finance this charge over the loan term? If you remodel your main home, the deductibility of the points charged will depend on the ratio of the remodeling cost to the total amount of the new mortgage and on the method of payment for the points.
Refinancing for Better Rates
If you pay off your mortgage loan with a new loan carrying a lower rate of interest (or more favorable terms overall), all of your interest on the loan will usually be deductible as acquisition debt. Any points you pay on the new loan will be deductible over the loan term.
Refinancing or Home Equity Loan to Raise Cash
You cannot deduct the interest paid on a consumer loan to pay for a personal asset or expense, such as a new car or medical expenses. However, you can transform that nondeductible expense into fully deductible interest using your home as collateral for the loan if the total amount of such home-equity debt does not exceed $100,000. The loan can be a first mortgage, a second mortgage, or a home equity loan. The appropriate loan for you will depend on factors such as how much you will pay in closing charges (including points), how much interest you will pay, and the size of the outstanding home loan amount.
For further information about tax planning opportunities, contact the Henssler Financial’s Tax & Accounting Division. We can assist you with further information regarding this issue, as well as any other tax related issues. Contact our experts at 770-429-9166 or [email protected].