Tip No. 7: Tax Breaks for Home Refinancers

If you refinanced your home last year and remodeled, too, you might be entitled to an often-overlooked tax break.

DID YOU REFINANCE your mortgage last year? You just might be eligible for some often-overlooked tax savings. If you paid points when you refinanced your mortgage — and you used some of the mortgage proceeds for home improvements — you should be able to immediately deduct those points rather than amortizing them over the lifetime of the loan.

To qualify for the break, the home must be your main residence. And unfortunately, you can only deduct the points in the same proportion as the proceeds that were related to home improvement. The remaining balance of points must be amortized. Here's an example:

Say your old mortgage was $200,000, and you took out a new 30-year, $240,000 mortgage. You spent the additional $40,000 on a new den and major kitchen-remodeling project. And you paid 1 1/2 points (which is the equivalent of 1.5% of the loan, or $3,600) to get the new loan. You can then immediately deduct one-sixth (40,000/240,000) of the refinancing points, or $600, on your 2000 return. Claim your $600 deduction on Line 12 of Schedule A. The catch? You must have paid at least that amount out of your own pocket to get the new loan.

Using our same example, you can take amortization deductions for the percentage of points not related to home improvements over the loan's 30-year term (360 months). In this case, you would be able to deduct an additional $8.33 ($3,000 of remaining points divided by 360 months) for each month the new loan was outstanding during 2000. (Not much to brag about, but, hey, it does add up.) Claim the amortization write-off on Schedule A, again using Line 12. You can then continue claiming amortization deductions on future tax returns for as long as the loan is outstanding.

What happens if you simply refinanced your old mortgage without taking on any additional debt, or just enough additional to cover the refinancing's transaction costs? In either of these circumstances, you can generally claim amortization deductions for the points. In other words, in our example, there's no immediate deduction for the $600.

Keep in mind, if this isn't the first time you've refinanced, then you can most likely also immediately deduct the points on your old mortgage. Chances are, you probably have a fairly healthy unamortized (not-yet-deducted) balance for those points. And you can generally deduct that entire amount when you refinance again. So even if you were amortizing your old points, now you can completely deduct them on your 2000 returns, in addition to deducting your new points (which you might deduct immediately or amortize, depending on the circumstances described above).

Let's say you refinanced last year. The mortgage you replaced was taken out in a previous refinancing deal done five years earlier — back in 1995. At that time you paid $1,800 in points for your 30-year loan. You should have $1,500 worth of unamortized (not-yet-deducted) points left over from the 1995 loan (25/30 of the original $1,800 amount). So on your 2000 return, don't forget to deduct that $1,500 amount. Claim your write-off on Line 12 of Schedule A. Remember also to claim your rightful deductions for points on the new loan, as explained earlier.