Does Refinancing Change Your Cost Basis? Here’s What to Know

Refinancing a property can lower interest rates, reduce monthly payments, or provide access to cash, but it also raises tax questions. A key concern is whether refinancing affects the cost basis of a home or investment property, which determines capital gains taxes upon sale.

While refinancing typically does not change cost basis, certain expenses and specific types of refinancing may have an impact. Understanding these factors ensures informed financial decisions.

Factors That Establish Cost Basis

The cost basis of a property is the amount paid to acquire it, but this figure is not static. The purchase price includes acquisition costs such as title fees, legal expenses, and transfer taxes.

Beyond the initial purchase, improvements that add value, extend the property’s life, or adapt it to a new use can increase the cost basis. Examples include adding a new roof, upgrading plumbing, or expanding the structure. Routine maintenance, such as painting or minor repairs, does not qualify. Keeping records of improvements is important, as they reduce taxable gains upon sale.

Certain post-purchase costs may also affect the cost basis. Special assessments for infrastructure projects, such as new sidewalks or sewer lines, can be added if they directly benefit the property. Additionally, casualty losses not reimbursed by insurance may reduce the basis.

Refinancing Expenses That Could Adjust Basis

Most refinancing expenses are personal costs and do not affect the cost basis. However, if refinancing funds are used for capital improvements—such as installing solar panels or expanding living space—those costs can be added to the adjusted basis.

Loan-related fees generally do not qualify, but there are exceptions. If a lender requires a property survey or structural inspection as a condition of refinancing, and these assessments lead to documented improvements, the associated costs may be capitalized. Similarly, if refinancing includes a construction loan funding upgrades, the portion of closing costs attributed to the improvement project can be included in the basis.

Mortgage points paid during refinancing are typically amortized over the loan’s life for tax deduction purposes. However, if the refinanced loan funds home improvements, the points may be added to the cost basis. Proper documentation, such as contractor invoices and loan allocation records, is necessary to substantiate these claims.

Cases Where Refinancing Does Not Alter Basis

Refinancing replaces an existing loan with a new one but does not change the cost basis of a property. Since basis is tied to acquisition and capital improvements rather than financing terms, refinancing—whether to secure a lower interest rate, adjust loan terms, or switch between fixed and variable rates—does not modify the amount used to calculate future capital gains.

Closing costs, such as lender origination fees, appraisal charges, and title insurance, do not contribute to basis adjustments. These expenses are either deducted over time, such as mortgage points, or treated as personal costs. Unlike acquisition-related title fees, which are included in the original basis calculation, title insurance for refinancing only protects the lender’s interest in the new loan.

Debt restructuring through refinancing, including extending the loan term or consolidating multiple loans, does not change the cost basis. Even when refinancing removes a co-borrower—such as in a divorce settlement—the transaction does not affect the basis, as ownership interest in the property remains intact.

Cash-Out Refinancing Implications

A cash-out refinance allows homeowners to replace an existing mortgage with a larger loan, receiving the difference in cash. While this does not directly affect cost basis, how the withdrawn funds are used carries tax consequences.

If the cash is used for personal expenses, such as paying off credit card debt or discretionary purchases, there is no impact on the property’s basis. The additional borrowed amount is simply new debt secured by the home. However, if the funds are reinvested into income-producing assets, such as purchasing another rental property or securities, borrowers may need to track interest deductibility under IRS tracing rules (Regulation 1.163-8T). Interest on loans used for investment purposes may be deductible if properly allocated and documented.

A common misconception is that cash-out refinancing allows homeowners to access equity tax-free indefinitely. While the loan proceeds are not taxable, any capital gains realized upon selling the property remain subject to taxation. The original cost basis remains unchanged, and gains are taxed under Section 121 exclusion limits or long-term capital gains rates, depending on eligibility.

Impacts on Depreciation for Investment Properties

For rental properties, refinancing does not change the depreciation schedule or the basis used for tax deductions. Depreciation is based on the property’s cost basis, excluding land value, and is typically spread over 27.5 years for residential rental properties or 39 years for commercial real estate under the Modified Accelerated Cost Recovery System (MACRS).

If refinancing funds are used for capital improvements, the portion allocated to upgrades can be added to the property’s adjusted basis and depreciated separately. For example, if a landlord refinances and spends $50,000 on a new HVAC system and structural renovations, that amount is depreciated over its applicable recovery period rather than being lumped into the original depreciation schedule. The IRS requires that improvements be tracked separately, with different assets potentially subject to varying depreciation timelines. Additionally, interest on the refinanced loan may be deductible as a business expense if directly tied to the rental activity and properly allocated.

Recordkeeping and Documentation Steps

Maintaining accurate records ensures refinancing transactions are properly accounted for in tax filings and financial planning. Since only certain refinancing expenses impact cost basis or depreciation, clear documentation is required to distinguish between deductible costs, capitalized improvements, and personal expenditures.

Loan documents, closing statements, and receipts for any improvements funded through refinancing should be retained and categorized appropriately. Taxpayers should maintain a detailed ledger tracking how refinanced funds were used, particularly if portions were allocated to property upgrades. Depreciation schedules should be updated to reflect any new capitalized improvements. Using accounting software or consulting a tax professional can help streamline this process, reducing the risk of errors that could lead to penalties or missed deductions.