Cash Out Refinances and Taxes – A Quick Guide
People often turn to cash out refinance in order to unlock equity and access cash. While they’re an effective means of liquidizing some of your property assets, people often have a lot of questions regarding their taxes with this product, such as is cash out refinance taxable?
What is a cash out refinance?
Firstly, let’s quickly define what we mean by cash out refinance. This financial product replaces your existing mortgage with a new loan for more than you currently owe. You then get to keep this difference as cash, so it can be a great way to unlock the equity that you’ve built up in a property.
How is a cash-out refinance different from traditional financing, such as re-mortgaging? Well, traditional financing replaces your existing mortgage for a new one of the same value. On the other hand, cash-out refinancing allows you to borrow up to 80% to 90% of your home equity.
What are the tax implications of a cash out refinance?
A great thing about refinancing is that the majority of the time you don’t have to pay income taxes on the money you receive through a cash out refinance. The reason for this is because the money doesn’t technically count as ‘income’.
However, the rules and regulations around what is and isn’t considered ‘tax-free’ has changed in the last couple of years.
Tax breaks on a cash out refinance – then and now
The mortgage interest deduction allows you to subtract interest paid on your mortgage debt from your income.
In the past, you could claim the deduction on $1.1m in total mortgage debt. This included up to $100,000 in home equity debt. This lump sum could be used for any purpose.
However, from tax returns filed out in 2019 and onwards, interest paid on cash out refinancing is only tax deductible if used to purchase or make improvements to your property. Furthermore, the new limit for loans is $750,000.
What are some of the home renovations that are tax-deductible?
These changes are more commonly known as ‘capital home improvements’. It applies to any addition that adds longevity to your property, increases its value, or adapts it’s appeal to a new market.
These renovations may include:
A swimming pool
A new bedroom
A home office
However, you don’t have to go all out with your property renovations. Here are some smaller changes that fall under this bracket:
- A central heating system of air conditioning
- Installing a home security system
- Storm windows
It’s worth noting that home repairs don’t add value to your property and aren’t categorized as a capital home improvement. Therefore, under the Tax Cuts and Jobs Act of 2018, they aren’t tax-deductible.
The verdict on cash-out refinancing
A cash out refinance makes a lot of sense if you have an excellent use for the money, or if you are making capital home improvements that can be tax-deductible.
However, as briefly discussed, there is a gray area about what home renovations are and aren’t considered tax-deductible. It’s worth consulting with cash out refinance experts or an accountant who specializes in property taxes before taking the plunge.