Is a cash-out refinance taxable?

A woman seated at a desk in her home office that she set up using funds from a cash-out refinance.Image: A woman seated at a desk in her home office that she set up using funds from a cash-out refinance.

In a Nutshell

You won’t usually have to pay taxes on the cash you get from a cash-out refinance. But you will need to meet certain criteria to qualify for a deduction on your interest.
Editorial Note: Credit Karma receives compensation from third-party advertisers, but that doesn’t affect our editors’ opinions. Our third-party advertisers don’t review, approve or endorse our editorial content. It’s accurate to the best of our knowledge when posted.

A cash-out refinance turns some of your home equity into cash. But since it’s considered a loan instead of income, a cash-out refinance typically isn’t taxable.

You might even qualify for a tax deduction if you take out a cash-out refinance. Here’s a closer look at the tax implications of a cash-out refi and how you might be able to use it to save on your tax bill.

What are the tax implications of a cash-out refinance?

When you take out a cash-out refinance, you replace your current mortgage with a new, larger loan and pocket the difference as cash. The cash you receive is a type of debt you’ll need to repay over time.

For that reason, the IRS doesn’t usually count it as income. Since a cash-out refinance is considered another loan, you don’t have to include the cash in your income calculation when you file your taxes.

Even though you probably won’t be on the hook for taxes on a cash-out refinance, there are tax implications you should know about.

In the past, one of the benefits of home loans like a cash-out refi was that you could deduct taxes on the interest you paid, no matter how you used the funds. This meant the IRS would give you back some of the money you paid on your tax return.

The Tax Cuts and Jobs Act of 2017 changed the rules regarding interest deductions on home loans. Now you’ll only qualify for a tax deduction on a cash-out refinance if you meet certain criteria, which we’ll go over below. You won’t get to deduct your interest automatically.

Can you write off a cash-out refinance?

If you use the cash for debt consolidation, for example, the IRS won’t let you deduct interest on your cash-out refinance. But you might qualify for a deduction if you put your proceeds toward the following:

Making capital home improvements

One way to lower your tax bill through a cash-out refinance is to use the cash for capital home improvements that increase your home’s value, improve its longevity or change it so that it adapts to new needs.

These may include permanent updates such as …

  • Adding a bath or bedroom
  • Installing energy-efficient doors or windows
  • Updating the roof
  • Upgrading the HVAC system

Setting up a home office

If you’re self-employed or a small business owner and add a home office, you might be able to deduct the interest you pay toward your cash-out refinance. To do so, you must use your home office for business purposes only and show that it’s the main place where you conduct your business.

To calculate your deduction, you’ll need to choose from one of these two methods.

  • Simplified method — Figure out the square footage of your home office and deduct $5 for each square foot. With this method, you can deduct up to 300 square feet or $1,500.
  • Standard method — If your home office is more than 300 square feet, the standard method is for you. It gives you a deduction based on the size of your office in relation to certain costs of your home.

Buying mortgage points

Another way to lower your interest payments on a cash-out refinance is to buy mortgage points. Points can reduce your mortgage rate. Keep in mind that if you go this route, you won’t be able to claim all your points the year you refinance. You’ll need to spread out your deduction over several years.

Let’s say you take out a cash-out refinance for 15 years and buy $2,000 in mortgage points. In this case, you could deduct $133 from your taxes each year you have the loan.

What’s next: Alternatives to consider

If you decide a cash-out refinance doesn’t makes sense for your situation, there are some alternatives to explore.

  • HELOC: A HELOC, or home equity line of credit, lets you borrow money against your home equity and pay it back much like you would a credit card.
  • Home equity loan: Home equity loans are similar to HELOCs but typically have fixed interest rates and lump sum loan amounts.
  • Personal loan: A personal loan may be an option to explore if you don’t have much equity in your home or don’t want to use it as collateral to borrow money.

About the author: Anna Baluch is a freelance personal finance writer from Cleveland, Ohio. You can find her work on sites like The Balance, Freedom Debt Relief, LendingTree and RateGenius. Anna has an MBA in marketing from Roosevelt Un… Read more.