is interest expense from rolling closing costs when refi home tax deductible

[hgtc]

Clients added $5,000 closing costs to a new loan when they refinanced their home mortgage.  Do we need to reduce their 1098 loan interests for the additional of $5k to original loan?

[rbynaker · Accepted solution]

---

@hgtc wrote:

Clients added $5,000 closing costs to a new loan when they refinanced their home mortgage.  Do we need to reduce their 1098 loan interests for the additional of $5k to original loan?

---

Sort of.  Here's my approach:  To the extent the closing costs are associated with the loan costs of refinancing (such as loan origination, loan commitment, abstract, and recording fees), they keep their "home acquisition debt" character.  But closing costs such as prepaid interest, insurance, real estate taxes and escrow deposits are not home acquisition debt since those loan proceeds were specifically used to pay other expenses.

In reality, consider a de minimis amount.  If this is $5K of closing costs on a $500K mortgage refinanced in October we're talking 1% of $3K of interest, or maybe $10 in tax.  Yes, I could spend the time and bill the client to figure this out down to the penny, but remember the repayments are taxpayer friendly and home acquisition debt is paid off last.  So by the middle of next year the loan proceeds will be 100% acquisition debt and nobody will care anymore.

[StknCPA]

Any costs, including loan acquisition costs and closing costs, on a refinance are not home acquisition debt.

https://www.irs.gov/publications/p936#en_US_2020_publink1000229994

The calculation for the amount of home acquisition debt in the new loan is equal to the home acquisition debt principal that was paid off with the new loan.

(If a portion of the new loan is used for additional home acquisition, that would add to the balance.)

Admittedly, this is only from an IRS pub--I have not researched for stronger authority.

[rbynaker]

I think the 10T regs are silent on this.  There is a clause in the 8T regs (related to other types of interest--so NOT exactly on point):

To the extent the proceeds of a debt (the “ancillary debt”) are used to pay borrowing costs (other than interest) with respect to another debt (the “primary debt”), the ancillary debt is allocated in the same manner as the primary debt is allocated from time to time.

Most of the closing costs I see are not loan related and there are often "lender credits" and/or "broker credits" which wipe out the loan related costs anyway.

But I certainly wouldn't fault you for just doing what the Pub says.  If they're just financing closing costs and not taking other cash out then the problem goes away in a year to 18 months.  If they're paying off a car loan or credit card debt then I'm definitely throwing everything into a spreadsheet and grinding the numbers out.

[hgtc]

thanks.