Refinancing your mortgage may be a smart move, but it's not much of a tax loophole. Most of your refinancing fees -- appraisal, inspection, loan origination -- don't give you any sort of write-off. You can deduct some of your other closing costs, but only if you itemize deductions on Schedule A. If you take the standard deduction, you're out of luck.
Points -- prepaid interest due at closing -- are a legitimate deduction. Unlike prepaid interest on your initial mortgage, you can't take them off for the year you close: You have to amortize the points over the life of the loan. If you pay $3,000 in points and you have a 30 year mortgage, you get to deduct $100 every year. Real estate pros also use points to refer to other, nondeductible closing costs. Don't try to deduct them along with the interest or the IRS may come calling.
When you use part of your refi to improve your home, you can deduct some of the points the year you take out the loan. For example, if your mortgage is $180,000, you refinance at $200,000 and use $20,000 for a major remodel, 10 percent of your points are immediately deductible. This only applies if prepaying interest is a standard practice in local real estate and if your payment is no higher than usual.
The IRS has a lot of "thou shalt nots" on the mortgage- nterest deduction. For starters, you can only deduct mortgage interest on your primary residence and your second home. You can only deduct interest on debt of up to $1 million: If you carry $2 million in mortgage debt after you refinance, only half the points and interest are deductible. If you refinance for more than the value of your home, you can only deduct interest from the amount of the mortgage equal to your home's value.
If your lender requires you take out mortgage insurance when you refinance, any premiums you pay are deductible. When you have to make a prepayment penalty on your old mortgage to get a refinance, you can write off the penalty as if it were added interest. If you haven't completely amortized points from your previous mortgage, you take them off your taxes the year you close on your refi, if you use a new lender. If it's the same lender, you amortize the remaining old points over the life of the new loan.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.