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Military Finances 301: The Potential Tax Tripwire When You Refinance Your Mortgage

Taxes

From my experience, many active and retired Senior Military Officers and NCOs own real estate. Over the past few years as interest rates have dropped, it has made pretty good sense to refinance mortgages to take advantage of lower rates and to save some money. But you need to be careful because the Tax Cuts and Jobs Act (TCJA) also known as the New Tax Law, changed the tax treatment of mortgage interest.

Home Equity Interest Deduction Changed

Prior to the TCJA, home equity interest on a balance of up to $100,000 was deductible. If you had $150,000 in home equity interest, 2/3 of that interest will be deductible (approximately). That is no longer the case. Under the TCJA no home equity interest is deductible. Zero. Zip. Nada.

It's Not What It's Called. It's What It Is

The TCJA specifically states that only interest on acquisition debt is deductible. Acquisition debt is defined as debt that is obtained to purchase or improve real estate. If the debt is used for any other purpose, the interest on it is not deductible. What that means is that if you refinance a mortgage on your home and take some equity out to pay off credit cards, the interest on the portion of the loan used to pay off the cards is not deductible. It doesn't matter that the loan is called a mortgage and not a home equity loan. Conversely, if you take out a home equity loan and use the proceeds to build a new deck, that would be home acquisition debt. That is true even though the loan is called a home equity loan.

And by the way, if you refinanced 5 years ago and took out equity, the interest on the equity you took out back then isn't deductible either.

You're Responsible for the Calculations

You are required to determine the amount of interest that should not be deducted. It won't be reported on your Form 1098. You also need to track the pay-off of the loan. You're allowed to allocate all principal paid off during the year towards the home equity portion. So, over time you'll deduct a larger and larger portion of the interest paid.

Confused Yet?

While the TCJA was supposed to simplify the tax code (and many parts are simplified), it certainly made the mortgage interest deduction more complicated. If you'd like some help getting your taxes done, we can help you with that. If you'd like to plan your taxes as part of your overall financial plan, we can help with that too. Give us a call.


If you found this article useful, you might like the following blog posts:

Retired Military Finances 201: Understanding Depreciation Recapture


Military Finances 101:  Becoming a Landlord


Military Finances 101: 8 Real Estate Books to Read Before Buying Your First Home




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