Can You Deduct Taxes on a Cash-Out Refinance?

Homeowners often explore cash-out refinancing as a way to tap into their home’s equity, but questions about the tax implications of such financial moves can be complex. Understanding whether you can deduct taxes on a cash-out refinance is crucial for making informed financial decisions.

Loan Proceeds and Tax Considerations

The IRS does not treat loan proceeds from a cash-out refinance as taxable income since they are considered a loan that must be repaid. However, the use of these funds can have tax implications, particularly if directed toward investment or business purposes. For example, if proceeds are used to purchase investment property or fund a business, the interest on the loan might be deductible as investment interest or a business expense, subject to specific limitations. The IRS allows deductions for interest on loans used for investment purposes under Section 163(d) of the Internal Revenue Code, capped at the amount of net investment income. Similarly, business-related interest expenses are deductible under Section 162 if they are ordinary and necessary for a trade or business.

The Tax Cuts and Jobs Act of 2017 limits the deductibility of mortgage interest to cases where home equity loan funds are used to buy, build, or substantially improve the home securing the loan. If the funds are used for personal expenses, such as paying off credit card debt, the interest is not deductible.

Mortgage Interest Deductions

The IRS permits deductions on interest paid on acquisition debt, which refers to loans used to buy, build, or improve a qualified residence. For tax year 2025, the deduction limit is $750,000 for married couples filing jointly and $375,000 for single filers, as outlined in the Tax Cuts and Jobs Act.

If cash-out refinance proceeds are used for substantial home improvements, such as a new roof or kitchen remodel, the interest on that portion of the loan may qualify as acquisition debt and be deductible. However, if the funds are used for non-home-related expenses, such as a vacation or personal loans, the interest on that portion does not qualify for a deduction.

The IRS requires homeowners to maintain detailed documentation, including receipts and contracts, to substantiate that funds were used for qualifying improvements. Proper record-keeping not only helps maximize deductions but also provides evidence in case of an IRS audit.

Points and Origination Fees

Points, or discount points, are fees paid to the lender at closing to secure a lower interest rate. The IRS allows for the deduction of these points on a cash-out refinance if they are used for home improvements. For instance, $3,000 in points paid on a $200,000 loan for a kitchen renovation could be deductible.

Origination fees, charged by lenders for processing a loan, may be deductible if classified as interest and if the refinanced funds are used for qualifying home improvements. However, fees categorized as service charges typically do not qualify for tax benefits.

Using Funds for Repairs or Improvements

Using cash-out refinance proceeds for home repairs or improvements can enhance a homeowner’s financial position. Projects such as energy-efficient windows or modernizing an HVAC system can increase property value and potentially provide tax advantages. These improvements boost home equity, which can strengthen financial stability and future borrowing options.

Certain home improvements may also qualify for energy efficiency tax credits or state-specific incentives. For example, the Residential Energy Efficient Property Credit can offset costs for solar panels and other renewable energy installations. This dual benefit of increasing home value and reducing tax liability makes using cash-out refinance proceeds for such improvements an appealing option.

Document Preparation for Filing

Accurate documentation is essential to claim any tax benefits associated with a cash-out refinance. The IRS requires records to validate deductions, and failure to maintain them can result in disallowed claims or penalties. Homeowners should organize loan-related documents, including the closing disclosure, loan agreement, and receipts or invoices for expenses paid with refinanced funds.

For home improvement projects, it is important to keep contracts, permits, and detailed receipts as proof that the funds were used for qualifying expenses. These records should clearly align with the loan disbursement dates and amounts to avoid discrepancies during tax filing.

Consulting a tax professional can simplify this process. They can help categorize expenses, calculate deductible amounts, and ensure compliance with IRS requirements. For example, they may determine whether points paid on the refinance are fully deductible in the current tax year or need to be amortized over the loan term. Working with an expert reduces the risk of errors and maximizes potential tax savings.