With a cash-out refinance, you replace your current home loan with a new one and borrow more than you owe so that you can take advantage of the equity in your home — and access cash at closing.
While the tax benefits on cash-out refinances aren’t as generous as those for original mortgages, you can still deduct part of the interest paid if you use your cash for certain purposes. Keep in mind — we’re not tax attorneys and this is not legal or tax advice. We just want to let you know about some general tax implications associated with cash-out refi choices.
Are cash-out refinances taxed as income?
So, do you have to pay taxes on a cash-out refinance? The good news is no.
The IRS doesn’t generally consider loans, even mortgage refinance loans, as income because the expectation is that you will pay the money back. As such, you don’t have to report it when you file your taxes. The loan amount might be taxable if it is forgiven or canceled, though.
However, even though you don’t have to pay income taxes on the cash-out refinance, there are still cash-out refinancing tax implications.
Find out: Mortgage Refinance Tax Deductions Every Homeowner Should Know
How to deduct the interest on your cash-out refinance
It’s possible to claim a mortgage interest deduction, but you need to itemize using Schedule A if you plan to do so. Additionally, there’s a hard limit on the amount you can claim, whether you’re getting an original mortgage or you’re refinancing.
For 2024, you can deduct mortgage interest on the first:
- $750,000 if single or filing jointly
- $375,000 if married filing separately
However, in addition to itemizing your interest, there are other cash-out refinance tax implications to be aware of. It’s always a good idea to touch base with your accountant or tax attorney to see how cash-out refi choices could affect you and your bottom line.
1. Make capital home improvements
One way to claim a mortgage interest deduction on a cash-out refinance is to show that you’re using the money for capital home improvements. These are permanent renovations that increase the home’s value, improve its longevity, or adapt it for new needs. The list below is not exhaustive — it’s to give you a sense of what types of improvements qualify.
It’s also worth noting that if you use your cash-out refinance to install renewable energy equipment, you may be eligible for an additional credit equal to 26% of the cost.
Tip
No matter what improvements you make, be sure to keep detailed records so they know how much was spent on the capital improvements. Good records are important in the event of an audit.
Learn More: Swimming Pool Loans: Finance with a Personal Loan
2. Set up a home office
Small-business owners or self-employed persons can deduct mortgage interest, insurance, utilities, repairs, maintenance, and depreciation for their home office from their federal taxes.
While it’s not a direct mortgage interest deduction, if you can set up a home office using a portion of the money from your refinance, there are some potentially positive tax implications.
Before you claim a home office tax deduction, though, you need to make sure you meet the following requirements:
- Regular and exclusive use: The area you use must be regularly used for business activities, and you can only deduct the area used exclusively for business.
- Principal place of business: Your designated area must be where you principally conduct business.
When calculating your deduction, there are two methods you can use: the simplified method and the standard method.
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Depending on your situation, one method might provide a bigger deduction than the other. Consider your situation and run the numbers to see what works best for you.
See: Reasons for a Cash-Out Refinance: How to Use Your Home Equity
3. Buy mortgage points
One way to reduce your interest rate on a refinance is to buy mortgage points. Each point is equal to 1% of the amount of the loan and can reduce your APR depending on how many points you pay for.
However, it’s important to note that you can’t claim all of your points in one year. Instead, you spread out your deduction over the years.
Example
If you get a cash-out refinance for 15 years and pay $3,000 in points, you can spread out that deduction to claim $200 per year.
You will need to itemize to claim the deduction for points, so you might need to take advantage of other itemized deductions listed on Schedule A to effectively claim a points deduction. Check with your accountant to see if this makes sense for you.
Check out: Should You Get a Cash-Out Refinance to Invest?
Using your cash-out refinance for non-deductible purposes
Even if you aren’t getting a tax deduction, your cash-out refinance can still be financially worthwhile.
A good example is the potential to use your cash-out refinance to pay down high-interest credit card debt. Generally, your mortgage rate will be much lower, so you might be able to save thousands in interest and get out of credit card debt faster.
Keep Reading:
- Cash-Out Refinancing vs. Home Equity Loan: How to Choose
- Using a Cash-Out Refinance to Buy a Second Home: A Good Idea?
Alternatives to cash-out refinancing
If you don’t want to use a cash-out refinance to meet your financial goals, you can also get a home equity loan or a home equity line of credit (HELOC). These loans won’t give you extra cash, but you still get access to the equity in your home. There is also the option to take out a personal loan.
