What Are the Tax Implications of a Cash Out Refinance?

Will Taking Cash from Your Home’s Equity Affect Your Taxes?

If you need to pay down debt, make home upgrades, or manage a big expense, a cash out refinance can give you access to the cash you need. But does tapping into your home's equity impact your taxes? Here are some tax implications to consider when you choose a cash out refinance.

Cash Out Refinance: The Basics

A cash out refinance allows you to refinance your home for more than what you owe and receive the difference in a lump sum of cash. For example, say you bought a house several years ago for $275,000. Since then, home prices in your neighborhood have increased, and your home is now worth $340,000. That price increase also increased your home's equity, which you could then borrow from with a cash out refinance.

Do You Pay Taxes on a Cash Out Refinance?

No, the cash you receive from a cash out refinance isn't taxed. That's because the IRS considers the money a loan you must repay rather than income. The same is true for home equity lines of credit (HELOCs) and home equity loans.

Cash out refis don't trigger capital gains tax since you aren't selling the property. But they can increase your property taxes if you make home improvements that boost your home's value.

When Is a Cash Out Refinance Tax-Deductible?

You may be able to deduct your interest payments if you use the funds from a cash out refinance to buy, build, or substantially improve your home. These deductions are subject to limitations.

For tax years 2018 through 2025, you can't deduct your interest payments if you use the money to pay personal living expenses, such as paying down credit card debt. For example, say a borrower refinances a loan with a balance of $100,000 and takes out $75,000 in equity to pay down credit card debt. Because the proceeds weren't used for capital improvements, the borrower couldn't deduct the interest paid on the $75,000. However, the borrower could deduct the interest paid on the $100,000.

You can learn more on the IRS website.

4 Ways to Qualify for a Cash Out Refinance Interest Deduction

Here are four common ways you may qualify for an interest deduction from your cash out refinance:

1. Capital improvements: You must use the funds for substantial improvements that add value to your property, extend its useful life, or adapt it to new uses. This may include replacing a roof, remodeling a kitchen, upgrading HVAC systems, or completing major system repairs.
2. Renovate your rental property: If the property is a rental, interest may be deductible as a rental expense when funds are used for improvements or other qualifying rental-related costs. Keep in mind that rental deductions are reported differently from personal mortgage interest.
3. Build an addition to your property: Adding a new room (such as a home office) or building a structure like a garage or deck is typically considered a substantial improvement. Because these projects increase your property's value, the associated interest may be deductible.
4. Deduct mortgage points: If you pay mortgage discount points when doing a cash-out refinance to get a lower interest rate, you may be able to deduct them as mortgage interest. In most cases, refinance points must be deducted over the life of the loan rather than in the year they're paid.

Remember to confirm your tax breaks and responsibilities by consulting with a professional tax advisor.

Final Thoughts: Taxes on Cash Out Refinancing

A cash out refinance isn't considered taxable income. But the interest may be deductible if the cash out funds are used to buy, build, or substantially improve the property, subject to IRS rules and limits. If you're considering a cash out refinance, explore your options and see what you may qualify for. You can start by getting prequalified today.