Mortgage Interest & Cash Out Refinance for Future Remodel

[dmor1]

In 2021 I refinanced my primary residence, paying off a $90k outstanding mortgage with a $170k new mortgage at a lower interest rate. The $80k "cash-out" was used for closing costs and a new roof, with the remaining balance sitting in a designated bank account until a structural repair and a remodel are completed in 2022 and 2023. These expenditures will cost more than the $80k that was "cashed-out". To date, none of that money has been spent on anything, house related or not. Turbo Tax asks "Tell us how you've used this loan.". After I enter the amount spent on the roof, Turbo Tax's next screen asks if I'm done with entering 1098 and mortgage loan information and goes to the next topic. What is the proper tax treatment for this situation, with regard to deducting mortgage interest, and where in the TurboTax file can I go to see that it's been treated correctly? Thanks for your help.

[RaifH]

Any amount of the mortgage that is either used for the acquisition of the home or improvement of it is eligible as an itemized deduction. The interest paid on the portion of the mortgage that was not used to acquire or improve the home is considered home equity debt, which is not deductible. Depending on the nature of the improvement, that may or may not be an eligible deduction. It is eligible if it adds to the value of your home or improves the life of the home.

As long as the structural repairs and improvements are completed and paid for within two years from the closing of the loan, you may consider the entire $170,000 deductible. To report this in TurboTax:

1. Answer No to Is this the original loan you used to buy your property?
2. Answer Yes to Is this loan a home equity line of credit or a refinance of a previous loan
3. Answer Yes to Did you take cash out when you got this loan? 
4. Answer Yes to Have you used the money from this loan exclusively on this home?

Mortgage interest and property taxes are itemized deductions, as well as charitable contributions and medical expenses if you paid more than 7.5% of your gross income on medical expenses in the year. You may take either your itemized deductions or the standard deduction which is based on your filing status, but not both. Once entering all your itemized deductions, TurboTax will determine which is more advantageous to you, but you can also switch back and forth to see the difference. 

[Paul Misano]

Could you tell me where "As long as the structural repairs and improvements are completed and paid for within two years from the closing of the loan ... "   comes from? I did not see that in the IRS Pub 936.

Also, our remodeling will cost less than our 2021 cash-out amount, but we don't know yet how much it will be. Can we increase the acquisition debt portion of our 2021 refinance in 2022 or 2023 when we finalize the remodeling costs? How about in 2024?

Thanks. 

[Carl]

There's a lot concerning this that in my opinion, is just not clear in pub 936. One thing that matters is when the original loan was obtained - before or after October 12, 1987.

To start, you need to use table 1 on page 12 of pub 936. Take note that this is to figure your "CURRENT YEAR" (which is 2021) eligible interest deduction. Your yet-to-be paid for improvement costs won't get included until the tax year you actually use the cash out money to pay for them.

You are right to keep that money in a separate account, as if audited you have to be able to show the flow, as the tracing rules will matter.