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“The
catch you have to watch for is that all of the interest on your house may not
always be deductible,” she says. “In order for the interest to be entirely
deductible, the total of your mortgage loan cannot exceed the cost
basis of your home.”
Well,
that’s a lot to understand, but then that’s why God created accountants!
Here’s what it all means:
The
biggest thing you need to understand is that there is a big difference between
your home’s cost basis and it’s market, or appraised, value.
“The
cost basis of your home is the price you bought is for, plus the cost of any
major improvements such as additions, garages, original landscaping and
fencing.”
Any
money spent to add to your existing home counts as an improvement that adds to
the cost basis of your home. If you’ve replacing or upgraded parts of your
home that already existed – such as new carpeting or a new roof – those
expenses are not considered improvements and don’t add to the cost basis.
So
let’s say you bought your house 20 years ago for $54,000. Since that time
you’ve made a number of home improvements that add up to $85,000. That means
that today, the cost basis of your home is the $54,000 purchase price plus the
$85,000 in improvements, or $139,000.
The
catch comes in the appraisal of your home. In Royal Oak, for example, the market
value of homes is quite high. Your home’s cost basis may be $139,000, but if
an appraiser tells you that its market value is $280,000.
“Wow!”
you think. You can refinance your home and get a new mortgage up $280,000 at
today’s lower rates. That would put a lot of cash in your pocket to invest, do
more home improvements or even take a trip. Even better, you’ve got the tax
deduction of all the interest you’ll pay on the new loan. Right? Wrong, says
Millian.
“If
your refinanced loan (or total loan amount if you’re taking out a second
mortgage) exceeds the cost basis of your home,” Millian says, “then the
interest is only deductible up to the percentage that your cost basis has to
your mortgage.”
For
another example, let’s say the cost basis of your home is $90,000. You have
your home appraised and refinance your mortgage at a lower rate for $180,000. The cost basis of your home is only 50% of the new
loan amount. Therefore, you can only deduct 50% of the interest you pay on the
new loan.
That’s
why you need to think about how much you want to refinance for and what you’re
going to do with the extra cash you get. If you decide to put it back into your
home in the form of improvements, that will add to the cost basis of your home
and make more of your interest deductible, Millian says.
“But
I would not recommend refinancing to reinvest the difference,” she says. “What you make off the investments
never covers the cost of borrowing the money in the first place.”
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