April 2, 1999

Tax relief That refinancing may offer

By TOM KELLY
The Real Estate Advisor

If you have promised to get to that pile of tax papers this weekend, take a moment and recall what major moves you made in 1998 before you dive into the stack. What many home sellers forget to factor at tax time are the fees remaining from a previous refinance. All of those fees can be deducted in the tax year you chose to refinance a second time.

For example, let's say you jumped at a 30-year, fixed-rate loan at 6.5 percent in February of 1998. In order to get that lower, you had to pay at least 5 discount points. If the loan amount were $80,000, one discount point would amount to $800, and five points would be $4,000. Points paid to buy, build or improve your principal residence can be deducted in the year they are paid, as long as they were not rolled into the loan amount.

However, because you refinanced to simply obtain a lower interest rate, nearly all of the $4,000 must be written off over the life of the loan. That's because the IRS sees refinancing points as repayment of existing debt. Last month, however, an unexpected need to send mom into a nursing home necessitated another refinance to pull some cash out of the home. You decide on an adjustable-rate mortgage with a very low starting rate and pay no fees. Now that the exisiting loan is paid off, the remaining balance of the $4,000 from the previous loan is deductible in tax year 1999.

Money spent fixing up your home for sale also is an overlooked expense, but can only be deducted in figuring your gain. Painting, decorating and minor repair costs are small items that many people overlook. These things add up and should definitely be included in the work you've done to the property to get it ready for sale.

"Fix-up work" must be done within 90 days before you sign a sales contract with a buyer, and the work must be paid in full no later than 30 days after the sale closes.

If you did refinance last year, double-check your numbers. You can only deduct interest on the amount of the loan at the time you refinance, plus $100,000. For example, let's say you purchased your home 20 years ago for $100,000 and took out a loan for $80,000. Since then, you have paid the loan down to $20,000.

The house is now worth $275,000 and your oldest child now needs college tuition. The house definitely has equity to tap, but your mortgage interest deduction would be limited to the first $120,000 ($20,000 old loan at the time of "refi," plus $100,000).

"If some of the money were used to fix up the home, then the situation could really change," said Conrad Gehrmann, tax attorney in the accounting firm of Arthur Andersen. "The portion used for construction would increase the total amount the borrower could deduct."

It's important to remember that home-loan interest deductions simply reduce your taxable income. They are not dollar-for-dollar tax credits that are subtracted from your tax bill. If you have a $1,000 a month mortgage payment and are in the 15 percent tax bracket, only about $150 a month escapes being taxed in the early months of the loan.

Unless you are haunted by an immediate want or need for a large sum of money -- for example, for medical expenses or major investment -- the decision to refinance should be based on how long you will be in your house. If you are going to be in the house fewer than two years, the fees and other costs may outweigh the lower interest rate.

Points are not fully deductible in the year in which they are paid because they were not paid in connection with the improvement or purchase of a home, even though the original loan met the requirements for deductibility.

Owning your own home and other real estate can be an investment that helps to reduce your taxes. But don't purchase or refinance real estate just because of the tax benefits. Often, the tax deductions always seem greater than they really are.

*** Correction:*** Last week, it was incorrectly reported that excise tax and title insurance costs are deductible on the sale of a primary residence. The sentence was intended to explain how to ascertain capital gain on investment property.

Previous columns:

• Tax issues for home owners, 03-26-1999
• The lure of 125% home equity loans, 03-19-1999
• Paying off that loan, 03-12-1999
• Suburbs getting density, 03-05-1999
• Option ARM a pretty good option, 02-26-1999
• On a roll: Realtor puts office on wheels, 02-19-1999
• Free rent: 8 years and counting, 02-12-1999
• Bill would help seniors lower their property tax, 02-05-1999