The Tax Implications of a Cash-Out Mortgage Refinance

Feb 18, 2024 By Susan Kelly

There are many considerations before deciding if a cash-out refinance the best financial option. With a cash-out refinance, you swap out your current mortgage for a new one and receive some or all of the difference in cash. 1 A cash-out refinance arranged when the borrower seeks a new, more advantageous mortgage and a lump sum of money. A cash-out refinance, however, does not result in taxable income.

Consider the cash-out refinance tax implications in addition to interest rates and the short- and long-term costs of a new home loan. Find out if cash-out refinances result in taxable income, how to claim a tax deduction, and more.

If you plan on itemizing your deductions on your tax return, you should be aware of the tax consequences of a cash-out refinance. The funds obtained through a cash-out refinance are not regarded as taxable income. You could qualify for a tax credit if you utilize the proceeds from your cash-out refinance to make significant renovations or upgrades to your property.

Is the money I get from my cash-out refinance taxable?

In some instances, such as when cashing in bonds or withdrawing funds from an individual retirement account (IRA), the proceeds are considered taxable income. But getting a remortgage with cash out is never one of them.

This is because the funds from a cash-out refinance a loan, not income, even though they are received in a lump amount.

Instead of withdrawing funds from a bank account funded by earned income, you are borrowing against the value of your property and will need to repay the loan with interest over time. You are not required to report the cash-out amount as income on your tax return.

How to Lower Your Tax Bill Through Refinancing

A tax deduction on the interest you paid was a significant perk of home loan products like a home equity line of credit (HELOC), home equity loan, or refinance in the past. In other words, the Internal Revenue Service refunded some of the money you forked up. However, in 2017, adjustments were made to the criteria for deducting mortgage interest. There are now strict regulations governing when and how tax breaks can be claimed.

Discount Points on a Mortgage

You can pay mortgage points, also known as discount points, at the time of closing in exchange for a lower interest rate on your loan. Points are considered prepaid interest and hence are tax deductible for conventional mortgages. 4 However, the tax deductibility of points earned with a cash-out refinance is amortized over the loan's term rather than being utterly available in the year the points were paid. 5 If you utilize the funds for home upgrades, however, you may be eligible for an upfront tax benefit provided you meet specific criteria.

To be eligible for this exemption from the IRS, you must first satisfy several criteria (such as living in the home for which the loan is being taken out, paying points being a standard business practice in your area, etc.) and then use the cash-out proceeds to make "capital improvements" to the property. To the extent that you satisfy those conditions, you will be eligible for a rebate on the points you've already paid.

Here's how it works: Suppose you take out a loan for $100,000 and put $10,000 of that toward renovations. If that's the case, you can deduct 10% of the points you paid from your taxes in the year you refinanced. So, if you put in $3,000 worth of points, your deductible would be $300. The remaining $2,700 would be amortized throughout the remaining years of the loan at a rate of $300 per year.

Methods of Deducting Taxes Owed on a Cash-Out Refinance

It is essential to itemize deductions on your tax return if you want to take advantage of tax breaks associated with a cash-out refinance. To put it another way, filing Form 1040 or 1040-SR and using Schedule A.9 to itemize deductions is obligatory. Mortgage interest payments are not deductible if you use the standard deduction.

The Home Mortgage Interest Deduction has had its dollar maximum reduced by the Tax Cuts and Jobs Act (TCJA), among other things (from the tax year 2018 until 2026). Interest paid on mortgages that don't exceed $750,000 isn't tax deductible as of right now. If you're married but filing separately, you can only claim $375,000. (Before the act, the ceiling was $1 million, or $500,000, for a married couple filing separately.

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