A cash-out refinance is a great option for homeowners who want to access some of their home’s equity. This can be ideal if you want to complete a home improvement project, pay off high-interest debt, or pay for another large expense.
However, before moving forward, it’s important to understand how a cash-out refinance affects your taxes, including whether the cash you receive is taxable. Keep reading as we dig into everything you need to know.
Key Takeaways
- The cash from a cash-out refinance isn’t taxable—it’s considered a loan, not income, so you won’t owe taxes on the money you receive.
- Mortgage interest on the cashed-out portion may be deductible, but only if you itemize your taxes and use the funds for qualified home improvements.
- Certain home improvements can maximize your deduction—projects that add value to your home may make more of your mortgage interest eligible for a tax break.
Is the Cash from a Cash-Out Refinance Taxable?
No—the cash you receive from a cash-out refinance is not taxable. It’s considered a loan, not income, so you won’t owe taxes on it when you file your return.
That said, there are tax rules to keep in mind. While the money itself isn’t taxed, the way you use those funds can affect whether you’re able to deduct the mortgage interest on your new loan. Using the cash for home improvements? That interest may be deductible. Using it to pay off credit cards or other personal debt? That portion of interest likely isn’t.
We’ll cover how these deductions work, what counts as a qualifying expense, and how to make sure you stay on the IRS’s good side.
How Mortgage Interest Deductions Work with a Cash-Out Refinance
With a cash-out refinance, you can still deduct mortgage interest just like any other mortgage as long as you meet the requirements. However, a cash-out refinance is treated slightly differently by the IRS.
First, a quick recap on interest deductions:
Deducting Interest from Your Taxable Income
Each year, your mortgage lender will send you Form 1098, showing how much interest you paid—this is the number you’ll use when itemizing deductions.
Mortgage interest can be tax-deductible, but only if you itemize your deductions instead of taking the standard deduction.
For 2024, the standard deduction is:
- $14,600 for single filers
- $29,200 for married couples filing jointly
To benefit from a mortgage interest deduction, your total itemized deductions (including mortgage interest, property taxes, etc.) must exceed your standard deduction.
IRS Limits on Deductible Mortgage Debt
The IRS caps how much mortgage debt you can deduct interest on. For loans used to buy, build, or improve your home, the limits are:
- $750,000 if you’re single or married filing jointly
- $375,000 if married filing separately
These limits apply to the total principal balance of all qualifying mortgages—not the amount of interest you paid.
That means that if you’re paying interest on a mortgage loan worth $800,000, only $750,000 of that balance’s interest is deductible.
How It Works in a Cash-Out Refinance
With a cash-out refinance, you’re replacing your original mortgage with a larger one and receiving the difference as a lump sum. You pay interest on the full amount of the new, higher loan. However, how you use the funds will determine how much of that interest is deductible.
You can deduct interest on the full new loan only if the cash-out funds are used for qualified home improvements.
If the cash is used for something else—like debt consolidation or personal expenses—you can only deduct interest on the portion that paid off your original mortgage.
Example:
You owe $200,000 on your home and do a cash-out refinance for $250,000.
- If you use the $50,000 cash to renovate your kitchen, you may be able to deduct interest on the full $250,000.
- If you use the $50,000 to pay off student loans, you can only deduct interest on the original $200,000.
Possible Tax Deductions with a Cash-Out Refinance
How you use the cash from your cash-out refinance could impact your available tax deductions. Here’s how some things could impact your taxes.
Capital Home Improvements
Capital Improvements made to your home include things that add value. Some common capital improvements include:
- Finishing the basement
- Adding a bathroom
- Installing a swimming pool
- Replacing the roof
- Installing a fence around your yard
- Replacing your HVAC system
- Replacing old windows with energy-efficient windows
However, it’s important to understand that only home additions count as capital improvements, not home repairs. This means you wouldn’t be able to deduct mortgage interest if you used your equity to pay for:
- Repairing the HVAC
- Painting a room in your home
- Replacing a door handle or lock
- Replacing the interior flooring
- Replacing a broken ceiling fan
- Replacing a leaky faucet
Check out our guide to renovation refinances to learn more.
Home Office
A home office addition is considered a capital improvement, so you can deduct your mortgage interest.
Plus, if you’re self-employed or run a small business, a home office can have other tax benefits. You’d be able to claim a home office deduction, which can help reduce your taxable income even more. However, there are a few guidelines to follow when claiming a home office deduction:
- Regular and exclusive use: The area of your home must be used regularly and only for business purposes. This means if your home office also serves as a guest bedroom, you won’t be able to claim a home office deduction.
- Principal place of business: Your home office must be where most of your business work takes place.
When calculating your home office deduction, you need to follow one of two rules:
- Simplified method: If your home office is less than 300 square feet, take the total square footage and multiply that by $5 to get your total deduction.
- Standard method: If your home office is greater than 300 square feet, calculate the total square footage of your home office as a percentage of your entire home. Then, multiply this and your total mortgage payment to calculate your home office deduction.
Calculating The Home Office Deduction
Let’s consider an example using the standard method to fully understand how to calculate the home office deduction.
Let’s assume you have a 500-square-foot home office and your home is 3,000 square feet. This means your home office is 16.67% of your home’s overall square footage. If your mortgage payment is $1,900, your home office deduction would be $316.73 ($1,900 x 16.67%) monthly.
Renovations on a Rental Property
You might also use the money from a cash-out refinance to upgrade a rental property. These expenses are tax-deductible and can be used to offset your rental income.
Additionally, you can deduct mortgage interest, insurance, and any mortgage points purchased on the rental property.
Related: Getting a Cash-Out Refinance on an Investment Property
Mortgage Points
Purchasing mortgage points is one of the easiest ways to reduce your mortgage interest rate. Each point costs 1% of the mortgage amount, and each point reduces your interest rate, often by 0.25%.
However, federal regulator the Consumer Financial Protection Bureau says, “The amount that your interest rate is reduced depends on the specific lender, the kind of loan, and the overall mortgage market. Sometimes, you receive a relatively large reduction in your interest rate for each point paid. Other times, the reduction in interest rate for each point paid could be smaller. It depends on the specific lender, the kind of loan, and market conditions.”
The cash from a cash-out refinance can often be used to purchase these points.
When you use a cash-out refinance, you won’t be able to deduct the total cost of buying mortgage points in the year when your refinance takes place. Instead, you spread the cost equally during the loan. For example, if you purchase $5,000 worth of mortgage points on a 30-year mortgage, you can claim a deduction of $167.67 each year.
Down the Road: Capital Gains Taxes
A cash-out refinance won’t trigger capital gains taxes by itself—but it could affect your tax situation when you eventually sell the home.
Capital gains taxes are based on the difference between your sale price and your adjusted cost basis (which includes the original purchase price plus the cost of any capital improvements). If you used your cash-out funds for upgrades that qualify as capital improvements—like a new roof or finished basement—you can add those costs to your basis. This could reduce the taxable portion of your gain when you sell.
Also, keep in mind:
- If you’ve lived in the home for at least two of the last five years, you may qualify to exclude up to $250,000 of capital gains ($500,000 if married filing jointly)
- Paying down your mortgage with the proceeds from a future sale isn’t a deductible expense—so plan accordingly
Tip: Keep records of any improvements you make using your cash-out funds. They could help reduce your tax bill later.
Talk to a Tax Professional
Taxes can get complicated, especially when large sums or rental properties are involved. A qualified tax professional can help ensure you’re maximizing deductions and staying compliant.
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