Homeowners can't deduct closing costs such appraisal fees, loan preparation fees, attorney fees or notary fees for a refinancing unless the property being refinanced is a rental property. You can deduct any points you pay to refinance the mortgage on either a rental property or your main home. Qualified points are interest you pay in advance to get a lower loan rate. A point equals one percent of the amount you borrow.
Deducting Points
When you refinance your home mortgage, you can usually deduct points you pay the lender as a mortgage-interest expense. You must itemize deductions on Schedule A to take the deduction. Normally, you deduct points over the life of the loan. To find out how much prepaid interest you can claim on your tax return, divide the points you paid by the number of monthly payments you will make during the loan term. This will give you the interest expense you can deduct per month. The total amount of interest you pay in the tax year is what you can deduct on Form 1040 Schedule SE -- Supplemental Income and Loss.
Home Improvements
If you use money from refinancing your mortgage to make improvements to your home, a portion of the points may be fully deductible in the year you paid them. The improvements must add value to your home to qualify. According to IRS guidelines, you must use your home as collateral for the loan. Paying points must be an established business practice in the area where you live and you can't pay more points than what lenders normally charge. In addition, you must use the cash method of accounting to report income and deduct expenses when you file your taxes. Also, a lender can't charge you points to waive other loan fees and the points you pay must be as much as the costs you pay to close the loan.
Rental Property
If you refinance the mortgage on a rental property, you can deduct expenses you paid to get the loan on your federal income tax return. Along with points you pay upfront, you can claim settlement costs such as bank fees, title search fees, processing fees and recording fees. The only catch is the fees must be prorated over the length of the loan. To figure the expenses you can deduct for the tax year, divide the total closing costs by the total number of monthly payments you will make on the loan. Multiply that amount by the number of payments you made for the year.
Improvements to Rental Property
If you refinance the mortgage on a rental property to make major improvements, you may be able to fully deduct the amount of expenses related to the improvements in the year you take out the loan. For example, you refinance the mortgage for $200,000 and have $5,000 in closing costs. If you use $100,000 of the loan money to make improvements to the rental property, you can deduct half of the total closing costs, or $2,500 as expenses for the year.
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Amber Keefer has more than 25 years of experience working in the fields of human services and health care administration. Writing professionally since 1997, she has written articles covering business and finance, health, fitness, parenting and senior living issues for both print and online publications. Keefer holds a B.A. from Bloomsburg University of Pennsylvania and an M.B.A. in health care management from Baker College.