If you refinance your home is it tax deductible

If you need to pay down debt, do a home improvement, or expect 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 have to 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 particular situation.

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

You may be able to deduct interest costs of a cash out refinance from your taxes if you use the money to make capital home improvements to your home. Capital improvements are permanent upgrades that might increase your home’s value and can include things such as:

• Updating the roof
• Installing energy-efficient windows or doors
• Upgrading heat or air conditioning
• Adding a bedroom or bath
• Building a swimming pool
• Installing a security system
• Adding a home office

Not all upgrades are considered capital improvements, like repairs or painting your home. If you are using the cash from the refinance to pay down debt or other purposes, you can’t deduct the interest either. Consult your tax professional to understand the tax implications of your cash out refinance.

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 $350,000 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.

Ask Freedom Mortgage about cash out refinances

We offer cash out refinances with conventional, VA, and FHA loans. If you have questions about how we can help you refinance and get cash from your home’s equity, visit our Get Started page or call one of our experienced Loan Advisors at 877-220-5533.

* 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.

Our goal is to give you the tools and confidence you need to improve your finances. Although we receive compensation from our partner lenders, whom we will always identify, all opinions are our own. Credible Operations, Inc. NMLS # 1681276, is referred to here as "Credible."

Most homeowners refinance their mortgage to qualify for a lower interest rate, adjust their payment terms, or tap into their home equity.

But you can also benefit from several mortgage refinance tax deductions. These deductions, which you can claim after you refinance your mortgage, minimize the amount of federal income taxes you owe — and you shouldn’t leave any on the table.

Here’s what you need to know about mortgage refinance tax deductions:

• What is a refinance tax deduction?
• Standard vs. itemized deductions: What you need to know
• 4 refinance tax deductions your need to know
• What you can’t deduct on a mortgage refinance

What is a refinance tax deduction?

When filing your taxes, you may have the opportunity to claim tax deductions and tax credits. Both reduce the amount of taxes you owe but affect your tax situation differently:

• Tax deductions reduce your taxable income. For example, the mortgage interest deduction allows you to deduct the interest paid on your mortgage that year from your income, lowering the amount of tax you owe.
• Tax credits, on the other hand, provide a dollar-for-dollar reduction of your tax liability. For instance, if your tax liability is $5,000 and you have a tax credit of $1,000, applying the tax credit would reduce your liability to $4,000.

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What expenses can I deduct?

When you refinance your mortgage, several expenses can be tax-deductible and are similar to purchasing a home. You may already claim some of these deductions if you file an itemized tax return.

Some of the overlapping tax deductions for buying or refinancing a home include:

• Mortgage interest payments
• Mortgage insurance premiums
• Mortgage points
• Rental property closing costs

While you pay for the qualifying expenses upfront, the deduction reduces your taxable income on your tax return. The tax deductions for a mortgage refinance can apply to your primary home, secondary home, or rental property.

Good to know: The Tax Cuts and Jobs Act of 2017 (TCJA) reduced the number of tax-deductible home loan expenses and also doubled the minimum number of deductions to file an itemized return.

In most cases, you can only deduct the interest payments for a mortgage or a cash-out refinance if you use the funds to “buy, build, or substantially improve” your main home or second home, according to the IRS.

Another notable tax reform change is reducing the mortgage interest deduction to $750,000 in qualifying debt for mortgages originating after Dec. 15, 2017.

Standard vs. itemized deductions: What you need to know

The TCJA tax reform doubled the standard deduction for taxpayers. Your filing status determines the minimum amount of deductions you need to claim itemized deductions on Schedule A of your Form 1040 federal tax return.

Here are the standard deduction amounts for the 2021 tax year:

In addition to qualifying mortgage expenses, some of the itemizable deductions include:

• Charitable contributions
• Medical and dental expenses
• State and local income, sales, and property taxes

For example: A married couple filing jointly has $4,900 in “below-the-line” itemized deductions with $30,000 in eligible tax deductions:$30,000 total deduction – $25,100 standard deduction = $4,900 itemized deductionIn this tax situation, it makes sense to itemize and deduct the qualifying mortgage expenses.

However, you’ll need to claim the standard deduction if your itemized deductions don’t exceed the standard deduction amount for your filing status.

4 refinance tax deductions you need to know

While you won’t be able to deduct all mortgage refinancing costs, here are several common deductions.

Mortgage interest

At a glance: Deduct mortgage interest payments on the first $750,000 for primary and secondary homes.

The mortgage interest deduction is the easiest of the refinance tax deductions to qualify for. Your lender will send Form 1098 when you make at least $600 in annual interest payments. Interest payments for the original mortgage and any refinance count towards your deduction limit.

You can deduct interest payments for up to $750,000 in combined mortgage debt for a primary and secondary home. The deduction limit is only $375,000 if you’re married filing separately.

The interest payments for a home equity loan can also qualify if you only use the loan proceeds to buy, build, or improve the house acting as collateral.

Note: The deduction limit remains $1 million for “grandfathered” mortgages originating on or before Dec. 15, 2017.

Don’t Miss: How to Get the Best Mortgage Refinance Rates

For rate-and-term mortgages

A rate-and-term refinance replaces your interest rate, mortgage term, or both with new terms and leaves your equity intact. Your home must secure the loan for the interest to be tax-deductible.

For cash-out refinances

To qualify for a tax deduction on your cash-out refinance, you’ll need to use your available equity to perform capital improvements on the residence securing your mortgage.

The capital home improvements can help you qualify for additional tax deductions.

Using the loan proceeds for other purposes such as consolidating credit card debt or going on vacation makes the interest non-deductible.

Tip: If you refinance for more than the original mortgage amount, the interest for the excess debt isn’t deductible. For example, if you refinance a new loan for $50,000 more than your original principal, the interest payments for the extra proceeds are non-deductible.

Learn More: Cash-Out Refinance Tax Implications

Discount points

At a glance: Points that prepay home mortgage interest can be deductible.

Purchasing mortgage points reduces your interest rate as you prepay interest. Typically you’ll deduct the points over the life of the loan, but you might be able to deduct the entire expense in the same tax year you refinance.

Some basic requirements to claim the full deduction include:

• Your primary residence must secure the loan
• The cost of points can’t be more than the general cost for your area
• You substantially improve your primary home
• The points don’t cover miscellaneous fees or property taxes

Check out the IRS’ requirements to determine if you qualify for a full mortgage points deduction this year.

Rental property closing costs

At a glance: Closing costs for rental properties can be tax-deductible unlike for a personal residence.

Most rental property closing costs are tax-deductible on Schedule E and don’t require filing an itemized return.

Some of the eligible costs include:

• Abstract fees
• Legal fees
• Recording fees
• Title insurance

However, some expenses cannot be deducted when you refinance your rental property. One example is mortgage points when the loan amount is larger than the original balance.

For instance, if you took out a cash-out refinance on an investment property that appreciated in value, any portion of the points that exceeds the original loan balance can’t be deducted as a rental expense.

What you can’t deduct on a mortgage refinance

Unfortunately, the mortgage refinance tax deduction doesn’t apply to closing costs for your primary or secondary home.

You can only deduct personal mortgage-related expenses that report on Form 1098.

These mortgage refinance fees are not tax-deductible:

• Appraisal fees
• Attorney fees
• Credit report fee
• Escrow charges
• Inspection costs
• Legal fees
• Recording fees
• Title insurance

If you prepay interest for future tax years at the refinance closing, you’ll most likely need to deduct a portion of the payment on future tax returns.

Not being able to deduct these fees increases your refinancing costs. The best refinancing companies, however, can minimize your non-deductible expenses and help you qualify for better loan terms.

About the author

Josh Patoka

Josh Patoka is a personal finance authority and a contributor to Credible. His work has been published on Fox Business and several award-winning personal finance blogs including Well Kept Wallet, Wallet Hacks, and Frugal Rules.