Debt Consolidation

Gregory J. Cook, EA, CPA+
Accredited Tax Advisor
Past President Alabama Society of Enrolled Agents
Past President Alabama Association of Accountants

Things you should be aware of before you undertake an aggressive program.

Borrowing Against Your Primary Residence
There are scenarios where the mortgage interest you pay on your primary residence may not be tax deductible! Home mortgage interest is deductible if the loan is for acquisition debt or the refinance of acquisition debt, loan is to make substantial improvements to the home, or the loan is "home equity" debt.

Home Equity Debt
Home Equity Debt is defined as a mortgage you took out after October 13, 1987 that; does not qualify as home acquisition debt or as grandfathered debt (grandfathered debt is a mortgage that was taken out prior to October 13, 1987) and is secured by your qualified home.

Example
You bought your home for cash 10 years ago. You did not have a mortgage on your home until last year, when you took out a $20,000 loan, secured by your home, to pay for your daughter's college tuition and your father's medical bills. This loan is home equity debt.

Home equity debt limit. There is a limit on the amount of debt that can be treated as home equity debt. The total home equity debt on your main home and second home is limited to the smaller of:
$100,000 ($50,000 if married filing separately), or

The total of each home's fair market value (FMV) reduced (but not below zero) by the amount of its home acquisition debt and grandfathered debt. Determine the FMV and the outstanding home acquisition and grandfathered debt for each home on the date that the last debt was secured by the home.

Example
You own one home that you bought in 2000. Its FMV (Fair Market Value) now is $110,000, and the current balance on your original mortgage (home acquisition debt) is $95,000. Bank M offers you a home mortgage loan of 125% of the FMV of the home less any outstanding mortgages or other liens. To consolidate some of your other debts, you take out a $42,500 home mortgage loan [(125% × $110,000) − $95,000] with Bank M.

Your home equity debt is limited to $15,000. This is the smaller of:

$100,000, the maximum limit, or

$15,000, the amount that the FMV of $110,000 exceeds the amount of home acquisition debt of $95,000.

Debt higher than limit. Interest on amounts over the home equity debt limit (such as the interest on $27,500 [$42,500 − $15,000] in the preceding example) generally is treated as personal interest and is not deductible. But if the proceeds of the loan were used for investment, business, or other deductible purposes, the interest may be deductible.

Have You Refinanced Your Home?
If you are one of thousands who locked into a lower home mortgage interest rate, then you've hit the savings jackpot! Besides getting one of the lowest rates in decades, you may be able to deduct some of the refinancing costs when you file your tax return.

The “points” paid to get a home mortgage may be deductible as mortgage interest when you itemize on Form 1040's Schedule A. Points paid to get an original home mortgage may be fully deductible in the year paid. However, points paid solely to refinance a home mortgage usually must be deducted over the life of the loan.

For a refinanced mortgage, you figure the interest deduction by dividing the points paid by the number of payments you will make over the life of the loan. You may deduct points only for those payments made in the tax year. Say you paid $2,000 in points and you will make 360 payments on a 30-year mortgage. You could deduct $5.56 per monthly payment, or a total of $66.72 if you made 12 payments in one year.

If you used part of the refinanced mortgage money to finance improvements to your home and if you meet certain other requirements, the points associated with the home improvements may be fully deductible in the year the points were paid. Also, if you are refinancing a mortgage for a second time, the balance of points paid for the first refinanced mortgage may be fully deductible at pay off.

Other closing costs – such as appraisal fees and other non-interest fees – generally are not deductible. And the amount of your adjusted gross income could affect the amount of deductions you can take.

Any way you look at it, between the lower interest rates and the tax savings, that's money you can take to the bank.

For more information on deductions related to refinancing, contact your Cook & Co. Advisor.

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The Recovery Act was passed by Congress and signed into law by President Obama on February 17, 2009. The purpose of the $787 billion Recovery package is to jump-start the economy to create and save jobs. The Act specifies appropriations for a wide range of federal programs, and increases or extends certain benefits under Medicaid, unemployment compensation, and nutrition assistance programs. The legislation also reduces individual and corporate income tax collections (to an extent), and makes a variety of other changes to tax laws.

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This Act will have far reaching consequences and we will be dealing with it for years to come (at least until 2018). Twenty-eight different agencies – such as the Departments of Education; Health and Human Services; and Energy – have been allocated a portion of the $787 billion in Recovery funds. Each agency develops specific plans for how it will spend its Recovery Act funds. The agencies then award grants and contracts to state governments or, in some cases, directly to schools, hospitals, contractors, or other organizations. The agencies are required to file weekly financial reports on how they are spending the money and their specific activities related to Recovery funds.

Read more about The Recovery Act

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Have You Refinanced Your Home?
If you are one of thousands who locked into a lower home mortgage interest rate, then you've hit the savings jackpot! Besides getting one of the lowest rates in decades, you may be able to deduct some of the refinancing costs when you file your tax return. The “points” paid to get a home mortgage may be deductible as mortgage interest when you itemize on Form 1040's Schedule A. Points paid to get an original home mortgage may be fully deductible in the year paid. However, points paid solely to refinance a home mortgage usually must be deducted over the life of the loan.

For a refinanced mortgage, you figure the interest deduction by dividing the points paid by the number of payments you will make over the life of the loan. You may deduct points only for those payments made in the tax year. Say you paid $2,000 in points and you will make 360 payments on a 30-year mortgage. You could deduct $5.56 per monthly payment, or a total of $66.72 if you made 12 payments in one year. If you used part of the refinanced mortgage money to finance improvements to your home and if you meet certain other requirements, the points associated with the home improvements may be fully deductible in the year the points were paid.

Also, if you are refinancing a mortgage for a second time, the balance of points paid for the first refinanced mortgage may be fully deductible at pay off. Other closing costs – such as appraisal fees and other non-interest fees – generally are not deductible. And the amount of your adjusted gross income could affect the amount of deductions you can take. Any way you look at it, between the lower interest rates and the tax savings, that's money you can take to the bank. For more information on deductions related to refinancing, contact your Cook and Co. Advisor.