Are refinance closing costs tax deductible on rental property

Interest rates are at historic lows and many property investors are searching for a better deal on their mortgage. When weighing up the costs and benefits of refinancing, investors need to be aware of what refinance costs are tax deductible on rental property to boost their cash flow.

In this article, we will answer the following:

• Are refinance costs tax deductible?
• How are costs deducted?
• Why investors choose to refinance
• Some costs are considered capital and will impact capital gains tax

Key points:

• Refinancing involves replacing an existing mortgage with a new one
• A key reason why someone refinances is to get a lower interest rate and reduced fees
• For investors, some of the costs of refinancing their rental property are tax deductible

Are refinance costs tax deductible on rental property?

Refinancing a mortgage is when a property owner replaces their existing loan with a new one. Unlike owner-occupier homeowners, property investors can benefit from many refinance costs tax deductions. Some of the fees an investor can expect to claim are:

• loan establishment fees such as the application fee
• early discharge fees
• fixed rate loan break fees
• any title search fees charged by your lender
• valuation fees charged by your lender
• mortgage broker fees
• lenders mortgage insurance billed to the borrower

The average cost of refinancing fees can change, so it’s always a good idea to discuss these with your lender to get a full picture.

How are the costs deducted?

If the total refinancing fees are more than $100, they can be claimed over a five year period or the term of the loan, whichever is earlier.

When an investor uses part of their refinanced mortgage for private purposes, all deductions must be apportioned. For example, if 30 per cent of their rental’s refinanced mortgage was used to purchase a new private residence, all deductions for the borrowing costs and ongoing interest expenses need to be apportioned.

Why property investors choose to refinance their mortgage

A property investor’s new mortgage could be with a different or the same lender. Deciding whether to refinance is a significant decision that should only be based on your own circumstances.

There are many reasons why an investor would decide to refinance their mortgage, such as to get a lower interest rate, shorter terms, reduced fees or changing their mortgage rate from a fixed to an adjustable rate.

Some costs are considered capital and will impact capital gains tax

Any capital costs that an investor incurs from refinancing aren’t tax deductible and instead form a part of the property’s cost base. Capital costs can include conveyancing fees, building and pest inspection fees, valuation fees when a private valuation is done by your solicitor and if applicable, stamp duty on the transfer of property.

The capital costs an investor may need to pay when refinancing their home can decrease the amount of payable Capital Gains Tax (CGT) when selling the property. We recommend speaking with your accountant to make sure all capital costs are included.

For more information about how BMT Tax Depreciation works closely with your accountant to maximise your return, request a quote or contact our specialist team on 1300 728 726.

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Homeowners can't deduct closing costs such appraisal fees, loan preparation fees, attorney fees or notary fees for a refinancing unless the property being refinanced is a rental property. You can deduct any points you pay to refinance the mortgage on either a rental property or your main home. Qualified points are interest you pay in advance to get a lower loan rate. A point equals one percent of the amount you borrow.

Deducting Points

When you refinance your home mortgage, you can usually deduct points you pay the lender as a mortgage-interest expense. You must itemize deductions on Schedule A to take the deduction. Normally, you deduct points over the life of the loan. To find out how much prepaid interest you can claim on your tax return, divide the points you paid by the number of monthly payments you will make during the loan term. This will give you the interest expense you can deduct per month. The total amount of interest you pay in the tax year is what you can deduct on Form 1040 Schedule SE -- Supplemental Income and Loss.

Home Improvements

If you use money from refinancing your mortgage to make improvements to your home, a portion of the points may be fully deductible in the year you paid them. The improvements must add value to your home to qualify. According to IRS guidelines, you must use your home as collateral for the loan. Paying points must be an established business practice in the area where you live and you can't pay more points than what lenders normally charge. In addition, you must use the cash method of accounting to report income and deduct expenses when you file your taxes. Also, a lender can't charge you points to waive other loan fees and the points you pay must be as much as the costs you pay to close the loan.

Rental Property

If you refinance the mortgage on a rental property, you can deduct expenses you paid to get the loan on your federal income tax return. Along with points you pay upfront, you can claim settlement costs such as bank fees, title search fees, processing fees and recording fees. The only catch is the fees must be prorated over the length of the loan. To figure the expenses you can deduct for the tax year, divide the total closing costs by the total number of monthly payments you will make on the loan. Multiply that amount by the number of payments you made for the year.

Improvements to Rental Property

If you refinance the mortgage on a rental property to make major improvements, you may be able to fully deduct the amount of expenses related to the improvements in the year you take out the loan. For example, you refinance the mortgage for $200,000 and have $5,000 in closing costs. If you use $100,000 of the loan money to make improvements to the rental property, you can deduct half of the total closing costs, or $2,500 as expenses for the year.

References

Writer Bio

Amber Keefer has more than 25 years of experience working in the fields of human services and health care administration. Writing professionally since 1997, she has written articles covering business and finance, health, fitness, parenting and senior living issues for both print and online publications. Keefer holds a B.A. from Bloomsburg University of Pennsylvania and an M.B.A. in health care management from Baker College.