4 min read Feb 08, 2024

Cash-Out Refinance Tax Implications: A Complete Guide

Over the past decade, the nation saw 2,000,000 cash-out refinance originations. Cash-out refinance allows homeowners to convert their home equity into cash.

Homeowners who require funds opt for a cash-out refinance when lending rates are going down. It works just like mortgage refinance, the only difference is that you get paid in cash.

A cash-out refinance is not taxable in itself, but the funds received have tax implications. Furthermore, the interest paid on refinancing is not taxable.

⚡ Interest on mORTGAGE Refinance is Tax Deductible

  • Interest on mortgage payments is tax deductible. You can subtract the interest you pay on your mortgage from your taxable income, reducing your tax liability.
  • For mortgages approved after December 15, 2017, a borrower can only deduct interest on up to $750,000 of mortgage debt.
  • With refinancing, any upfront points are deductible as long as they are used to reduce the interest rate. However, if you pay points for other reasons, such as to cover closing costs, they may not be deductible.

Is Cash-Out Refinance Taxable?

The funds you get from a cash-out refinance against your home equity are not considered taxable income by the IRS. However, if these funds are used for investing in stocks or buying a property, they may be subject to taxes.

How to Make Your Cash-Out Refinance Tax Deductible?

Here are the ways to make the cash-out refinance funds tax deductible:

  1. Capital Home Improvements: Use the cash-out funds to make capital home improvements. By this, you can increase the value of your home and make the interest on the loan tax deductible.
  2. Tax Implications for Adding a Home Office: Use the funds to add a home office. This way you will be able to deduct a portion of your mortgage interest. To qualify for this deduction, the home office must be used exclusively for business purposes.

Interest Deduction Requirements

To deduct your mortgage interest, you must meet the following requirements:

  1. Secured Debt: You can only deduct interest if your loan is secured by a qualified home. This includes your main home and a second home.
  2. Legal Liability: Interest is deductible if you are legally responsible for repaying the debt. For example, if you co-signed on a loan, you can’t claim tax deductions, since you are not responsible for making payments.
  3. Itemize Deductions: To claim the mortgage interest deduction, you must itemize your deductions on your tax return. This means you cannot take the standard deduction.

Tax Implications of a Cash-Out Refinance on Rental Property

When you do a cash-out refinance on a rental property, there are several tax implications to consider:

Deductible Interest

The interest on the cash-out refinance loan may be tax deductible if you use the funds to improve the rental property.

Depreciation Recapture

Depreciation recapture is a tax on the portion of the property’s value that has been written off as depreciation.

Moreover, if you have taken depreciation deductions on the rental property in previous years, you may be subject to depreciation recapture when you sell the property.

Capital Gains Taxes

When you sell the rental property, you may be subject to capital gains taxes on the difference between the sale price and the property’s adjusted basis.

Furthermore, the adjusted basis is the original purchase price plus the cost of any improvements and minus any depreciation deductions.

Passive Active Losses

If you have losses from your rental property, you may be able to deduct them against your other income, subject to certain limitations.

Bottom Line

Cash-out refinance is a good option if you need immediate funds and your home equity has increased. However, a home buyer must be aware of its tax implications.

We would advise you to consult a tax professional before opting for a cash-out refinance.

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FAQs

Can I deduct mortgage points on my tax return?

Yes, if the mortgage points are tax deductible, if paid as part of a home purchase or a home improvement loan.

Can I do a cash-out refinance to avoid capital gains?

No, since the home isn't sold with a cash-out refinance, its funds can't be considered as capital gains.

By what time is the cash-out refinance paid back?

The amortization of a cash-out refinance is typically between 15 to 30 years.

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