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Deductions & credits
@LLTaxQuestions wrote:
A few questions about this. Cash-out refi, refi amount 250, original balance 150. Cash out of 100.
1) Does it matter if the refi happened in the middle of the year? 100% of interest deductible until the refi date on the original amount for the first part of the year and a split percent of the total interest for the balance of the year (after the refi)? Or, I can only deduct the total interest for the year on the original balance (assuming no $ were put back into the home)?
2) On the part of the loan that was not put back into the house, I still have to pay interest on that part of the loan. Is any of that interest deductible since it is still loan interest?
3) Can any money that is put back into the home this year (up to April 15th of the current year) be counted as last year to be included in the total amount of interest deducted for last year?
Only interest on acquisition debt is deductible. Acquisition debt is debt used to buy, build or substantially improve the home. Assuming that all of your first mortgage was acquisition debt, then $150K of the new mortgage is acquisition debt and the rest is non-deductible equity debt.
1. The IRS uses an average balance method. This is described in publication 936 giving several confusing methods you can use, or simply take the monthly average from all your statements. If we assume you refinanced on June 15, then your monthly average balance might be roughly speaking (because you gradually pay off the balance):
151,000
150,800
150,600
150,400
150,200
150,000
250,000 (the new balance on the first of the month after the refinance)
249,500
249,000
248,500
248,000
247,000
--------------
2,395,000 divided by 12 = $199,583
Then the average balance of your acquisition debt would be:
151,000
150,800
150,600
150,400
150,200
150,000 (after you refinance, you pay off equity debt first so your acquisition debt stays the same)
150,000
150,000
150,000
150,000
150,000
150,000
========
1,803,000 divided by 12 = $150,250.
150250 divided by 199583=0.753, so 75.3% of your total interest for the year is deductible.
https://www.irs.gov/pub/irs-pdf/p936.pdf
Ideally, Turbotax will calculate this for you, but it doesn't hurt to check. Since Turbotax does not know your monthly balances, it will use a different formula from the instructions, so the results won't be identical but should be similar. You are certainly entitled to calculate your own figure and enter it manually instead of relying on the program calculation.
2. No, you can't deduct interest on equity debt. Neither can you deduct interest on other personal debts, for cars, credit cards, vacations, or anything else. Congress created the mortgage interest deduction to encourage home ownership as public policy, then limited it to mortgages less than $750,000 and to acquisition debt only so people couldn't rack up large deductible interest on equity debt that was not used for home ownership.
3. No, the amount of total debt, acquisition debt, and interest you can deduct on your 2022 tax return is determined on a month by month basis looking at your 2022 mortgage balances only.
I don't know what you mean by "put back into the home." If you mean, you pay off the loan balance, then your acquisition debt remains the same because you pay off equity debt first, but the percentage of interest that is allocated to the equity debt will increase, and will be reflected in the monthly calculation next tax season.
If you mean, you will spend the money to make substantial improvements, then again, you determine your acquisition debt on a month by month basis. If you pay for improvements in 2023, you can add them to the acquisition debt when you pay the bills, and that will raise your deductible interest percentage when you do the month by month calculation next tax season.
It's a bit unclear how long after the mortgage is taken out that you can make improvements and have them count as acquisition debt. A reasonable answer is probably 24 months. The instructions are not clear and the examples given relate to taking out a loan to buy a house before or after it is completed, and don't really cover refinance loans where you take the loan first and then make improvements with the money. But it is pretty clear that you can't make improvements years later and have them count in the mortgage calculation. The improvements must be made using the mortgage loan reasonably close in time to taking out the mortgage, and 24 months is used for related situations.
