By Kay Bell

If historically low mortgage rates turned you into a serial refinancer, beware of the tax pitfalls surrounding the deductibility of any points you paid on your new loan (or loans).

As a veteran homeowner, you’re already well acquainted with your house’s many tax breaks. You’ve claimed mortgage interest and property tax deductions for years. And when you refinanced the first time, you were wise enough to know that the interest on the new loan, although thankfully much less, still could help reduce your Internal Revenue Service bill.

Heck, you even knew how to make tax use of the new points you paid. In most cases, points paid on a refinanced mortgage must be deducted over the life of the loan. It’s not quite as good a tax deal as the immediate deduction for points you got on your original mortgage, but it still offers some savings.

Once, however, was not enough. You diligently followed mortgage rates (on Bankrate, of course) and were able to refinance again at an even lower rate. Even better, the new refi is with the same lender with whom you got your earlier refi. And because of your prior lending relationship, you saved on the subsequent refi’s closing costs.

But by doing so, you’ve sacrificed an immediate tax break when it comes to deducting points. (See Refinancing and tax deductions table at the end of this story.)

Special refi point rules
Each point is 1 percent of the loan amount. Lenders charge points as a way to make a profit and borrowers pay points in exchange for lower mortgage rates.

In refi cases, however, any points usually must be amortized over the life of the new loan. The main exception to this rule is when you get extra cash from a refi to make improvements to your home. In this case, you can deduct the points attributable to this improvement money all at once. But the portion of the points related to the refinanced existing balance are not eligible for immediate tax-deduction purposes; they must be amortized over the life of the refinanced loan.

Mark H. Misselbeck, CPA with Levine Katz Nannis & Solomon PC in Needham, Mass., gives this example:

You have existing home debt of $200,000 and refinance to $250,000 so you can put a $50,000 addition on the house. You pay 1 point ($2,500) for the refinanced loan. Since $500 in points is attributable to the amount you will use for the home improvement, that $500 is immediately deductible on your taxes. The remaining $2,000 in points is considered prepaid interest that must be amortized over the life of the $250,000 loan.

“Only if the loan proceeds from the refinance were totally used to purchase the principal residence or improve the principal residence would all of any points paid on a refinance be fully deductible,” notes Misselbeck. “This would usually not be the case, since the whole point of a refinance is to lower the cost of existing debt, not take out a totally ‘fresh’ amount of money, except in unusual circumstances, to improve a principal residence.”

But in many cases, homeowners use cash-out refi or home equity money for something other than home improvement, such as paying college costs or buying a car. Here they still can deduct the points paid on these loans, but not completely on one tax return. They must parcel out the point deductions in each tax year over the equity loan’s term.

To figure the annual deduction amount, divide the total points paid by the number of payments to be made over the life of the loan. For example, if you paid $1,500 in points on a 30-year refi (360 monthly payments), you can deduct $4.17 per payment, or a total of $50 a year, for each tax year of the loan.

Serial refinancing restrictions
What if the continuing interest rate drops prompted you to refinance again? The good news for most homeowners is that they don’t lose that portion of the first refi’s points that they’ve been amortizing.