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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 a home improvement, or manage a big expense, a cash out refinance can give you access to needed cash. 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.

What are the basics of a cash out refinance?

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 gone up and your home is now worth $340,000. That price increase also increased the value of your home’s equity. You might be able to borrow a portion of the value of this equity with a cash out refinance.

Is the cash from a cash out refinance taxable?

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 pay back rather than income. There could even be tax benefits depending on how you use the money. Consult your tax advisor to discuss how this could apply to your situation.

Can you get a tax deduction from a cash out refinance?

You may be able to deduct the interest on your original loan balance no matter how much equity you access from your home. However, the interest paid on the portion of your balance being added in the cash-out refinance may only be tax deductible under certain circumstances. For tax years 2018 through 2025, you may be able to deduct your interest payments if you use the money from a cash out refinance to “buy, build, or substantial improve [a] residence” according to the IRS. These deductions are subject to limitations.

Please note for tax years 2018 through 2025, you cannot deduct your interest payments if you use the money to pay personal living expenses such as paying down credit card debt. Learn more on the IRS website.

As an example, a borrower refinances a loan with a balance of $100,000 and takes out $75,000 in equity to pay down credit card debt. Due to the fact that proceeds were not used for capital improvements, the borrower could not deduct the interest paid on the $75,000. However, the borrower could deduct the interest paid on the $100,000.

How does deducting mortgage interest from taxes work?

The IRS generally lets homeowners who are single or file their taxes jointly deduct interest they pay on mortgage principal balances up to $750,000. If you are married but file your taxes separately, the limit is balances up to $375,000 for each person. If you pay points to get a cash out refinance, these costs may be tax deductible as well.

To learn more about mortgage interest tax deductions, see Publication 936 on the IRS website. Also consult with your tax professional to understand how mortgage interest costs can affect your taxes and which deductions are right for you.

* Freedom Mortgage Corporation is not a financial advisor. The ideas outlined above are for informational purposes only, are not intended as investment or financial advice, and should not be construed as such. Consult a financial advisor before making important personal financial decisions and consult a tax advisor regarding tax implications and the deductibility of mortgage interest and charges.

Last reviewed and updated January 2024 by Freedom Mortgage Corporation.

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