If you reworked your mortgage last year, you've earned a nice tax deduction. And if you borrowed a little extra, you might get a bigger break.
Low rates last year enticed many people to refinance their mortgages. And some cash-strapped refinancers decided to borrow even more money, in the form of a home-equity loan. If you fall into this category, be sure to claim all your rightful deductions on your 2004 return.
Deducting Your Mortgage Interest
Say your original mortgage was $200,000. On July 1, 2004, you took out a new 30-year, $300,000 mortgage and paid 1 1/2 points, or $4,500, for the privilege. (Each point represents 1% of your total loan amount.) You then used the extra $100,000 from the new mortgage to eliminate some high-interest credit-card bills, pay off your car loans and cover various other expenses.
Assuming your home was worth at least $300,000 when you refinanced, you have, in effect, two new mortgages as far as the Internal Revenue Service is concerned. The first $200,000 of your new loan (the balance on your old mortgage when you paid it off) is treated as "home-acquisition debt." And as you probably know, this interest qualifies as an itemized deduction on line 10 of your Schedule A. (Don't forget, however, that if your adjusted gross income in 2004 was greater than $142,700, or $71,350 if married but filing separately, this deduction is subject to the phase-out rules for itemized deductions.)
The remaining $100,000 of your new loan is treated as home-equity debt. The interest on this should also qualify as an itemized deduction on line 10 of your Schedule A. But keep one thing in mind: The IRS only recognizes home-equity loans up to $100,000; you can't deduct the interest paid on principal above that figure.
Also, if the home-acquisition debt plus the home-equity debt exceeded the fair-market value of your home, you generally can't deduct the interest on the excess debt. For example, say your home was worth $240,000 when you took out that new $300,000 loan. You can deduct the interest on the $200,000 of acquisition debt, but you can deduct the interest on just $40,000 of the home-equity debt. So you can deduct 80% ($240,000/$300,000) of the total mortgage interest on line 10 of your Schedule A. (The extra interest is generally considered a nondeductible personal expense, though there are a couple of exceptions, like if you used the loan proceeds to finance your small business.) Keep all of this in mind the next time you get a pitch for one of those 125%-of-value home-equity loans.
You can amortize the points related to the home-acquisition-debt part of the new loan ($3,000 in our example) over the life of the loan. Say it's a 30-year loan (360 months). Your amortization deduction would be $8.33 a month ($3,000 divided by 360), for a grand total of $99.96 a year. Every little bit helps, after all.
What about the points related to the home-equity debt ($1,500 in our example)? You can amortize those in the same proportion as the interest, provided that the home-equity debt is $100,000 or less, and the home's value isn't exceeded by the home-equity debt plus the acquisition debt. Claim the amortization write-off for your home-mortgage points on line 12 of Schedule A.
This brings us to our last potential deduction. If you had previously refinanced your mortgage and paid points, you probably have a good-sized unamortized (or not-yet-deducted) balance for those points. You can generally deduct that entire unamortized amount when you refinance again. For example, say the mortgage you refinanced last year was taken out in a previous refinancing deal done six years earlier, back in 1998. At that time you paid $2,000 in points for your 30-year loan. You should have $1,600 worth of unamortized points left over from the 1998 loan (80% of the original $2,000 amount). On your 2004 return, don't forget to deduct the $1,600 of unamortized points. Claim your write-off on line 12 of Schedule A.