When it comes to mortgage refinance, I want you to carry a big mortgage. Don’t keep the cash in your walls. But, if you get a cash-out refinance, be careful how you use the proceeds, for the IRS may take you to the cleaners if you’re not careful. Here’s why.
Unlike traditional debt, a home mortgage is the cheapest money you can borrow, and for most consumers it’s the only debt that’s tax-deductible. You can probably invest the cash-out refinance proceeds and earn a higher return. That’s why I encourage you to take the cash out of the home and invest it. However, this strategy only makes sense if you can obtain an investment return greater than the after-tax cost of the mortgage debt. But make sure you educate yourself with your mortgage refinance options..
Uncle Sam realizes that you get a big tax advantage with your home mortgage loan. To prevent you from getting a "double benefit," there are two types of investments that you can’t buy with mortgage Refinance proceeds: those that are tax-deferred or tax-free. This means you cannot use your mortgage money to buy tax-deferred annuities or tax-free municipal bonds. The reason: Uncle Sam doesn't’t want you to enjoy a tax deduction on the mortgage and then use the money to invest in securities that let you earn interest or profits that aren’t taxable.
But there is a way around it:
The key to success with this strategy is your money trail. It’s okay to own variable annuities and municipal bonds, even if you have a mortgage, provided that you can show that the money you used to buy these investments didn’t come directly from your mortgage refinance proceeds. In other words, the money used for these investments must come from your earned income or some other source.
Otherwise, you’ll lose your mortgage interest tax deduction.
Say you have $100,000 in investments and you want to get a new $100,000 mortgage refinance and use the money to buy annuities or municipal bonds. You can’t do that, so here’s what to do instead: sell your investments and use that money to buy the annuities or municipal bonds. Then, when you get the mortgage proceeds, use that $100,000 to repurchase the investments you’ve sold. This demonstrates that you didn’t use mortgage proceeds to purchase the tax-favored investments. And that’s imperative.
Article Ric Edelman From The Truth About Money.
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