Be VERY Careful When You Refinance

California real estate has been a great ride this decade.  Property values have almost tripled in some areas over the past 6-7 years.  May homeowners have use their new found wealth to pay off high-interest debt, improve their property, or even leverage into more properties; all sound ideas.

There is an old sheriff in town enforcing some oft-overlooked laws next year and it just may affect YOU!

A few things you should know about the deductibility of mortgage interest:

1- It is limited to $1.1 million.
2- You must itemize (Schedule A) to receive that deduction.
3- A fully-amortizing loan reduces your Acquisition Indebtedness each month.
4- An interest-only loan does not reduce your Acquisition Indebtedness; it remains level.
5- You are entitled to a $100,000 over the Acquisition Indebtedness as a home equity exclusion for tax deductibility.

Now, here's the catch.  The IRS monitors your interest paid on mortgages through a Form 1098. The IRS has no formal system to monitor the segregation of debt (how much was the Acquisition Indebtedness, how much is covered under the home equity exclusion, and how much is not deductible)...UNTIL NOW.

In 2007, lenders are required to report cash-out refinance transactions. That includes any and all refinanced loans that exceed the original Acquisition Indebtedness.  This means that if you bought a home in 2000 with a $250,000 loan against it and have subsequently increased that debt to $400,000, your qualifying debt for interest will be capped at $350,000, more if you paid down the loan through an amortized loan.  In California, that applies to MANY refinance transactions for homes owned more than three years.

Why is the IRS doing this?  Well, follow the money. The IRS has overlooked this common ignorance of the tax code because it really didn't affect the average Joe...until NOW.  The real estate boom gave homeowners a chance to use their home like an ATM and withdraw cash.  Now, the IRS wants it's pound of flesh.  If you've refinanced and pulled out cash over and above $100,00 above your Acquisition Indebtedness, you had better start paying attention to your deductibility of mortgage interest ...because Uncle Sam is...next year.

Comments

[Mark Vane]

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[Shawn]

Thanks for the post. Hopefully, a lot are enlightened. If I may add, for those who are using their home as an equity for a refinance, learn about equity home loan mortgage rate as it will come in handy.

[Trevor Howell]

Excellent post! Too many people are going into negative AM and foreclosures. :(

[Louisville KY real estate]

Great article. So many people get caught up in the refinancing game, it would be great to see everyone getting better informed.