Refinancing may or may not affect your taxes, depending on what type of refinancing you have used and how you file.
Generally, your mortgage only affects your taxes if you itemize your deductions.
And, if you used a simple refinance based on the interest rate and term, there will most likely be no tax consequences. A cash-out refinance may have some amount, but you won’t have to pay income tax on the capital you cashed out. Here’s what you should know.
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Tax Deductions and Refinancing
When you refinance a mortgage to get a lower interest rate or better terms, you’re really just taking out a new loan and using the money to pay off your existing mortgage. Generally, mortgage refinancing provides the same tax deductions as a home mortgage loan.
With any mortgage – original or refinanced – the biggest tax deduction is usually the interest you pay on the loan. Typically, mortgage interest is tax-deductible, meaning you can deduct it from your income if the following apply:
The loan is for your primary residence or second home that you are not renting out.
The loan is secured by your home. This means that your home serves as collateral for the loan; if you don’t make payments, the lender can foreclose on the home
You “itemize” the deductions on your tax return, which means you list all your deductible expenses, add them up, and then subtract the total from your income. An alternative to itemization is to claim a standard tax credit, which is a set amount you can claim regardless of your actual expenses.
When you use TurboTax, it helps you decide which itemized or standard deduction option will save you the most money. At the end of the year, your mortgage lender sends you a statement called a Form 1098 that explains how much interest you paid during the year.
If you paid “points” on your mortgage refinance, you can deduct them. Points are prepaid interest; you pay them upfront to get a lower interest rate during the period you repay the loan. One point equals 1% of the loan amount, so if you paid 2 points on a loan of $100,000, for example, you would pay $2,000. Glasses are sometimes referred to by other names, including:
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- Commission for issuing a loan
- Maximum loan commission
- Discount points
- Credit discount
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Points paid out as part of a mortgage refinance are generally required to be deducted over the life of the loan.
You close your mortgage refinance when you sign all the paperwork to formally take out a new loan and pay off the old one. A number of commissions and fees may apply. These closing costs can be hundreds or thousands of dollars and can include things like:
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- Evaluation fee
- Legal costs
- Inspection costs
- Legal and registration fees
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These expenses are generally not deductible when refinancing a mortgage if they are related to where you live.
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Ways To Make Your Cash-Out Refinance Tax-Deductible
You accept a loan with a higher principal and take the difference in cash when you take cash to refinance. The IRS treats refinancing a little differently than when you take out your first mortgage. In other words, the IRS views refinancing as a type of debt restructuring. This means that the deductions and loans you can claim when you refinance are less certain than when you originally took out a loan.
The new Tax Cuts and Jobs Act of 2017 increased the standard deductions for both single and married applicants but also reduced many of the deductions that homeowners could previously count on.
Under new tax laws, your insurance payments are tax-deductible. Some of the new rules also apply to refinancing. For example, you cannot deduct the total value of any discount points you pay at closing in the year you receive a new loan. However, you can deduct them from your new loan.
It is important that we take a detailed look at how cash refinancing works before we look at how the IRS views the money you receive from this transaction.
Essentially, you are replacing your existing mortgage with a loan with a higher principal balance. Your lender then gives you the difference in cash. You can use the money from the refinancing cash out for just about anything. Many homeowners use it for debt consolidation or home improvement.
The money you receive from such refinancing is not “free money”. This is a form of debt on which you must pay interest over time. The IRS doesn’t treat the money you take from cash refinance as income — instead, it’s considered additional credit. You do not need to include the money from the refinance as income when filing your tax return.
There are limits on the interest you can deduct on cash refinance, and there are several ways to claim tax deductions on a refinance. Let’s look at some of them now.
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- Major house renovation
You can deduct the interest you pay on the portion of the loan you refinance if you are doing a major renovation on your home. Anything that extends the life of your home, increases its value or adapts your home to a different market is considered a major improvement. - Adding a home office
The addition of a home office is a major improvement and allows you to deduct the cost of any interest you pay towards your cash refinancing. A home office may also offer additional tax credits if you are a small business owner or self-employed.
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You can use the money from the cash refinance to improve or renovate the rental property you manage. You can deduct these expenses from your federal taxes. Any improvements or repairs you make to a rental property are almost always tax-free. This is because the IRS treats any money you earn from rent as personal income. You can also deduct the closing costs, interest, and insurance you pay for your rental property from your income as business expenses.
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FAQs
Is A Cash-Out Refinance Taxable?
You can use the money from the cash refinance to improve or renovate the rental property you manage. You can deduct these expenses from your federal taxes. Any improvements or repairs you make to a rental property are almost always tax-free. This is because the IRS treats any money you earn from rent as personal income. You can also deduct the closing costs, interest, and insurance you pay for your rental property from your income as business expenses.
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Will refinancing make my property taxes go up?
No, refinancing will not have a direct impact on your property taxes – even if you get a new, higher refinance grade. This is because your property taxes are assessed by your local tax authority based on their own assessment of the value of your home. This will not be affected by your mortgage appraiser’s valuation.
However, if a lender’s assessment shows that your home is worth a lot more than your tax authority thinks, it could be a sign that you live in a country with rapidly rising property prices. So next year you can count on an increase in property taxes. But this is solely due to housing price inflation.
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Does Refinancing Affect Taxes?
When you complete your cash refinance the same or same day your property taxes are due, you may end up paying those taxes when you close the loan. If so, on your next tax return you can deduct what you paid in property tax at the time of the refinance.
Keep in mind that only property tax payments you make during the year can be tax-deductible. If you place cash in escrow to use for future property tax payments, you cannot deduct that money.
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Conclusion
The money you withdraw from your equity during the refinance is not considered income by the IRS. However, there are limits on the refinance deductions you can use when you refinance a loan. You can only discount the interest paid on a new loan if you are using the cash to make major repairs to your property. You can take advantage of additional deductions if you are self-employed or use the money to improve your rental property. You can also deduct interest points at a discount over the life of the loan.
