With cash-out refinancing, the goal is to turn your hard-earned home equity into cash. A cash-out refinance can be a great way to cover some home improvements or other large expenses.
Lenders typically allow you to refinance your home for about 80% to 85% of its estimated value, if you meet the requirement of having at least 20% equity. But what are the tax implications on the cash you receive?
When you cash-out equity in your home, that cash isn’t considered income, so no worries on paying income tax. Remember that refinancing is a loan, and therefore, not considered taxable income.
And even sweeter, you may qualify for a tax deduction or tax credit if you use your cash-out equity for major home improvements. However, improving your property can mean your home is appraised for a higher value, which could mean you end up paying more in property taxes in the long run.
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Before the Tax Cuts and Jobs Act of 2017, you were allowed to take a tax deduction on the interest you paid, regardless of how you used you cash-out refinance money. However, now the IRS may only allow you to deduct interest you pay on the portion of the refinance that you use on capital improvements on your home.
A capital improvement is something that increases the value or longevity of your home, like replacing old windows. Other home improvements, such as replacing hot water heaters or adding energy-efficient appliances, may earn you tax credits.
A tax deduction gets subtracted from your taxable income. A tax credit reduces how much you owe in taxes overall.
Capital improvements you can do with your cash-out refi that may qualify you for a tax deduction or tax credit include:
As you might have noticed, capital improvements are big investments. General home improvements such as painting, fixing a porch or replacing gutters are typically considered repairs and not eligible for tax deductions or tax credits. Be sure to talk to a tax professional if you’re interested in qualifying for tax credits or deductions.
If you’re looking to cash out your home equity to add a home office, there are other possible deductions.
For a home office to be considered for deductions, it must be used regularly or be the principal place of your business. Some office supplies may be eligible for deductions as well, such as printers, computers or other materials.
The IRS states that there are two ways to calculate home office tax deductions:
Only additions or upgrades to your home may qualify for interest deduction. Note that interest you pay on funds you use to consolidate debt or pay for personal expenses isn’t tax-deductible — consult a tax professional on the stipulations surrounding interest deductions.
A mortgage point — or discount point — is what a buyer pays directly to a lender in order to get a lower interest rate. This is also called buying down your interest rate.
Typically, points may be considered tax-deductible because the IRS counts points as prepaid interest.
If you cash out your equity, the points may still be tax-deductible but you have to spread out the deduction over the life of the new loan — but only if you use the equity in a tax-deductible way, such as home improvements.
For example, let’s say you paid $600 for a point and saved over $5k in interest over the life of your 30-year mortgage. That $600 is considered prepaid interest. Now, if you went for a 15-year refinanced mortgage and cashed-out your equity and used it in a deductible way, you could only deduct $40 per year of that $600 you paid in points.
For complicated tax implications, we recommend talking with your tax preparer or a tax professional.
If you go through with a cash-out refi on a rental property that you own, it still isn’t considered income and isn’t taxed as such. If you only acquired a new rental property in the last year, you may qualify for bonus depreciation, called the 100% bonus depreciation deduction.
It may allow you to deduct the full cost of some capital improvements done on a rental property in its first year. It will be available until the end of the 2022 tax year.
Oftentimes, refinancing means looking for another lender for a chance at better loan terms, such as a more favorable interest rate or more leeway with credit score requirements. Use our table to compare lenders and lender marketplaces by the type of home equity product you need. Disclaimer: The partners on Finder's mortgage comparison tables are sorted in alphabetical order.
To qualify for a cash-out refinance, you must have enough equity in your home. Typically, you need at least 20% in equity, and lenders generally refinance a home for around 80% to 85% of its valuation. If you’re refinancing a rental property, you may need upwards of 25% to 30% of equity to cash out.
If you qualify, the cash-out equity isn’t taxed because it’s not considered income — it’s part of a loan. And if you use that cashed-out equity for capital improvements, that work may be tax-deductible or earn you some tax credits.
Read our detailed guide on cash-out refinancing to compare lenders, lending marketplaces and cash-out refinancing alternatives.
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