How long do I report cash out of loan that has since been refi'd?

[Hope667]

The refinance we took out in 2019 we cashed out a few thousand dollars to pay off debt. We refinanced that loan in 2020. Do I have to continue to report that cash out money until we sell our home? Or only if we had that loan at any point in 2020?

[fanfare]

your cash out only comes into play in the year you do the refinance.  If the cash out is used to finance or improve your home, the interest on that part is also deductible.

If you refinanced again,  that first loan, it is gone from consideration and you have a new loan.

[Carl]

Let me give an example.

You purchase a home in 2010 for $100,000, putting $20,000 down and financing $80,000 of that. 100% of the interest you pay on that original loan is 100% deductible on the SCH A for the entire life of that loan.

In 2020 you owe $60,000 on that loan and you refinance the loan for $100,000, thus taking a $40,000 cash out. At the time of refinance your outstanding balance on the loan originally used to purchase the house was $60,000. But you refinanced for $100,000 taking $40,000, or 40% of the cash for "other purposes". So only 60% of the refiance loan was used to pay off the balance on the original mortgage. That means that only 60% of the interest on the new loan can be claimed on SCH A every year, for the life of the new loan.

Now if you used all or a portion of the $40,000 you cashed out to "maintain or improve" the home, that money can be included in and added to the percentage that you can claim on SCH A. Since it appears you used the cash out to pay off "other debt", the percentage of the interest reported to you on the 1098 that applies to the cash out percentage can not be claimed on SCH A.

[Hope667]

Going with your example, what if we refinanced that $100,000, loan to get a better interest rate? Now that $100,000 loan is at a zero balance and we have a new one that we did not take any cash out on. Do we continue to report that cash out from the original refinance? 

[Carl]

Do we continue to report that cash out from the original refinance?

Yes. But the percentage of the interest you can claim will be lower, assuming none of the cash out was used to maintain or improve the property that was refinanced. Here's an example, building on the previous example.

Original loan: $80,000   All interest is 100% claimed on SCH A.

10 years later at time of refi, balance on original loan is $60,000. Refi'd for $100,000 and did not use the $40K cash out to maintain or improve the home. Only 60% of the interest can be claimed on SCH A for the life of this new loan.

SCENARIO 1: Another 10 years pass and you now owe $80K on the $100K refi loan, and you refi again for $100K to cash out $20K. You do not use any of the cash out to maintain or improve the home that was refinanced.  Of the $80K owed on the loan (the 2nd loan) only 60% of it applied to the balance of the original loan> that's $48,000 you owe on the the property, of the original loan used to initially purchase that property.

So for the new loan (the 2nd refi) of $100,000, only 48% of the interest paid on that loan can be claimed on SCH A for the life of that loan.

SCENARIO2: Another 10 years pass and you now owe $80K on the 100K refi loan. You refi again for the $80K owed on that loan, with no cash out. Nothing changes, as you can still only claim 60% of the interest paid on the loan, each year, for the life of this new (3rd) loan.

[fanfare]

If you refinance, you already paid off some of that cash-out in the same way as you paid off some of your home loan.

you shouldn't be asked to carry that cash-out amount forever.

Most persons would not file that way. they'd report the new refinance loan as 100% home loan, if they did not take out more cash again.

[Carl]

 It's covered in IRS Pub 936 at https://www.irs.gov/pub/irs-pdf/p936.pdf on page 10. Parts titled "Home Acquistion Debt" and "Refinanced Home Acquisition Debt." Since a refi is not "acquisition" of the property since you already have acquired and own it, I'm not seeing how one can claim 100% of the 2nd refi loan as 100% acquisition debt. Especially since there was a cash out on the 1st refi that did not qualify for home acquisition debt.

[fanfare]

OK Carl, I hear what you're saying.

@Hope667 

I guess you can take those cheers down because my answer isn't correct.

I didn't go through his examples in detail.

after a refi, the interest you're paying on the amount borrowed to pay off the old remaining balance of acquisition debt is the most interest you can deduct. Good luck calculating that.

[Carl]

It's not that hard to figure really. Using my example above, only 60% of the first refi was acquistion debt. That percentage will never change for the life of the loan. Yes, I know it "could" change. But in this case I've not been provided any information to indicate even the possibility of a change. Therefore, not included in my example.

You refi the loan again. The outstanding balance on that 1st refi is $80K of which only 60%, or $48,000 is what remains of the acquisition debt.

So only the interest on $48K of the 2nd refi is acquisition debt. If that 2nd refi is for $100K, then only 48%, or $48K is acquisition debt. Therefore, only 48% of the interest paid on the loan each year for the life of the loan, is a SCH A deduction.