Can You Deduct Business Loan Refinancing Costs on Your Taxes? A Comprehensive Guide

When business owners refinance a loan questions often arise around deducting the costs involved. Can closing costs, origination fees and other expenses from the new loan be written off? Or are you stuck eating those costs?

The answer depends on the type of costs incurred and how the refinancing is structured. Like many tax situations loan refinancing involves nuance and ambiguity.

This guide examines the tax treatment of common refinancing costs, IRS rules around deductions exceptions and strategies to maximize write-offs. Read on to gain clarity on deducting loan refinancing expenses for your business.

Overview of Business Loan Refinancing

Refinancing a loan generally means taking out a new loan to pay off an existing business loan. There are several reasons companies refinance:

• Lower interest rate to reduce monthly payments
• Consolidate multiple loans into one
• Access cash by increasing loan amount
• Extend repayment term for more flexibility
• Switch from variable to fixed interest rate

The new loan can be with the same lender or a completely new financing source. As long as the proceeds are used to repay old loan balances, it’s considered a refinance.

Tax Treatment of Refinancing Costs

When refinancing any kind of loan, there are typically closing costs involved with the new loan. Common fees include:

• Origination fees
• Application and processing fees
• Administrative charges
• Attorney fees
• Recording fees
• Appraisal fees
• Title searches

Can these refinancing costs be deducted on business taxes? Unfortunately, the general rule is no, they cannot be deducted.

Refinancing is treated as repaying old debt, not acquiring new debt. Therefore, the loan costs are not deductible expenses because the new loan does not finance business operations or generate income.

However, there are some exceptions where deductions may be allowed, which will be covered later in this article.

IRS Stance on Refinancing Cost Deductions

The IRS addressed the deductibility of refinancing costs in a 2017 Field Attorney Advice memorandum (FAA 20172901F).

The memo examined a company that refinanced its term loans by amending the credit agreement with lenders. Some existing loans were replaced with new loans having different terms.

The company argued that unamortized loan costs from the old loans were deductible under the original issue discount (OID) rules when the debt was refinanced.

However, the IRS disagreed. They determined that refinancing existing debt was not equivalent to retiring old debt and issuing new debt. Therefore, the unamortized loan costs were not deductible.

This IRS ruling suggests refinancing costs would only be deductible if the old loan is completely extinguished and an entirely new financing arrangement replaces it.

Exceptions Where Refinancing Costs May Be Deductible

While refinancing costs are generally not tax deductible, there are some exceptions where write-offs may be allowed:

1. New Lender and Loan Amount Increased

If you refinance with a new lender and increase the loan amount significantly, the IRS may treat it as new debt rather than a continuation of existing debt.

In this case, the costs attributable to the new additional loan amount may be deductible under the OID rules. Any fees allocable to the old loan balance would still not be deductible.

2. Interest Paid with Refinancing

When refinancing, any accrued interest on the old loan that you pay off with the new loan should be deductible.

For example, if you owed $10,000 of accrued interest on the old loan, and that was paid as part of the refinancing, that $10,000 would likely qualify as an interest deduction.

3. Points Paid on Refinanced Mortgage

For real estate loans, points paid on a refinanced mortgage may be deductible over the life of the new loan. Points must be paid for the use of money, not services.

4. Treatment as Business Expense

Some refinancing costs may potentially be deducted as ordinary business expenses rather than treated as loan costs. For example:

• Legal fees for review of new loan terms
• Consultant fees for advising on refinancing
• Appraisal fees if not required by lender

This path to deduction is uncertain and would need to be supported if challenged by the IRS.

Strategies to Maximize Deductions on a Refinance

If you want to refinance an existing business loan but also want to maximize tax deductions, here are some strategies:

• Shop for the best loan terms, not just lowest fees. Higher interest rate may offer greater deductions.
• Pay loan points if possible – they are deductible over loan term.
• See if lender will let you add funds and structure as a new loan, not just refi.
• Pay off loan accrued interest with refinancing proceeds.
• Accelerate loan payments before refinancing to boost interest deduction.
• Pay as many fees as possible separately rather than rolling into loan.

As always with tax planning, be sure to consult a certified accountant to ensure your specific situation complies with IRS rules.

The Importance of Tracking Costs When Refinancing

Meticulous record-keeping is critical when refinancing to support potential deductions. You’ll need to:

• Allocate which costs relate to old vs. new loan amounts
• Classify fees by type – interest, points, services
• Maintain invoices and statements as evidence
• Properly amortize any eligible points or fees

Without proper documentation and cost segregation, the chances of successfully deducting refinancing costs will be very low.

Other Things to Keep in Mind

A few other tips when evaluating deducting refinancing costs:

• Disclosure requirements – IRS rules may require certain details to be disclosed on tax returns when deducting loan costs.

• Timing differences – Even if deductions are allowed, they may not provide a current tax benefit if losses exist.

• State tax treatment may differ – Some states follow federal tax law while others set their own rules.

As always, work closely with both your lender and accountant when refinancing to optimize the tax results.

The Bottom Line

In most cases, costs incurred when refinancing an existing business loan will not be tax deductible due to restrictive IRS rules. However, some exceptions exist that provide potential write-offs depending on how the refinancing is structured.

To maximize deductions, understand the technicalities involved and consult tax professionals to develop the optimal refinancing strategy. Keep meticulous records, follow IRS regulations, and document everything to improve your chances of deducting refinancing costs.