Mortgage Interest Deduction & Refinance Costs

[prkwork]

Simple example: If a client refinances a $500,000 mortgage (all acquisition debt) with a $510,000 mortgage, with the additional $10,000 only covering the refinancing fees, do we prorate the new mortgage interest and say we can only deduct 500/510, or 98% of it (assuming no fees are points)? Or do we consider the new mortgage interest 100% deductible.

Similar but one step more complex example: And thus, if a client refinances a $500,000 mortgage (all acquisition debt) with a $550,000 mortgage, with $10,000 in fees, $20,000 in enhancements (acquisition debt), and $20,000 in other uses, do we prorate the new mortgage's interest and deduct only 520/550, or 95% of it (assuming no fees are points)? Or do we consider the new mortgage 530/550, or 96%, deductible?

[prkwork]

I believe it is the former in each case. I just want to confirm that.

[dascpa]

Not all tax preparers' (properly) not deduct the % of interest associated with non-acquisition debt on refinance.  I do.  In your 2nd example you actually have 3 subsets of one mortgage:  refinance of acquisition debt (original debt as paid down), additional debt not acquisition debt and new debt related to improvements.  I would apportion that way.

[rbynaker]

It's not a fixed percentage.  It depends on the average balances which will be recomputed each year.  There are also taxpayer friendly ordering rules for repayments, see IRS Pub 936:

https://www.irs.gov/pub/irs-pdf/p936.pdf

There's a section on Mixed-use mortgages starting on page 12 and some examples and worksheets.  Since the "home equity" debt is repaid first, often this is only messy in the year of refinance (or the year after if the refi is late in the year).  Once the loan balance drops below the acquisition debt balance then you're back to 100% deductible.

Rick

[prkwork]

You provide very good information and it helps me going forward. However, my question essentially is whether the fees associated with refinancing (excluding points), if paid out of the new mortgage, are considered part of acquisition debt. I am assuming that they are not.

[rbynaker]

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@prkwork wrote:

You provide very good information and it helps me going forward. However, my question essentially is whether the fees associated with refinancing (excluding points), if paid out of the new mortgage, are considered part of acquisition debt. I am assuming that they are not.

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Not in my opinion.  The proceeds are not used to buy, build or substantially improve the property.  In many cases part of this ends up being cash-out because they fund a new escrow account for taxes/insurance and then after the old mortgage is paid off, the old bank refunds the old escrow balance.

[TaxGuyBill]

Publication 936:

Refinanced home acquisition debt.

Any secured debt you use to refinance home acquisition debt is treated as home acquisition debt. However, the new debt will qualify as home acquisition debt only up to the amount of the balance of the old mortgage principal just before the refinancing. Any additional debt not used to buy, build, or substantially improve a qualified home isn't home acquisition debt.

https://www.irs.gov/publications/p936#en_US_2022_publink1000229994

[prkwork · Accepted solution]

I really don't know why no one can just say "yes" or "no" and then cite the regs. So, I'll state the conclusion clearly: Fees (other than points) incurred in refinancing do not quality to be added into acquisition debt. Consequently, the presence of such non-acquisition amounts require a proration of the interest incurred on the new debt so that only the portion related to acqusition fees is deducted.

[TaxGuyBill]

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@prkwork wrote:

I really don't know why no one can just say "yes" or "no" and then cite the regs.

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Because we are not your personal research service?

Many of us are willing to help fellow tax professionals, and we have given you some great information.  But you can't expect us to always give a point-blank "yes" or "no".  You are a tax professional, not a little kid.

[prkwork]

Mine was only a suggestion for clarity, not to raise your hackles. To my "is this right" question, wouldn't it  be clearer to me and to others if one would just reply: "Yes, refinance fees do not count as acquisition debt." See [and then cite the reference in the Publication]. I am sorry that you did not find this helpful.