Refinancing your home and taking cash out can be a smart financial move, but many homeowners wonder if that cash counts as profit and what the tax implications might be. The simple answer is that refinancing does not count as profit and isn't taxable income, but there are nuances depending on the type of refinancing and how you manage the proceeds. In this article, we'll explore these nuances and help you understand the financial implications of refinancing your home.
What is a cash-out refi?
Refinancing involves replacing your existing mortgage with a new one, typically to take advantage of lower interest rates, change the loan term, and optional access to home equity. There are primarily two different types of refinancing:
1. Cash-Out Refinancing: This type of refinancing allows access to equity above and beyond the loan balance, but typically limited to 80% of the home's value. The first loan is paid off and you can withdraw the rest as cash. Homeowners use this option to consolidate debt, fund home improvements, or buy an investment property.
2. Rate-and-Term Refinancing: This more conventional refi option involves changing the interest rate, loan term, or both, without taking additional cash. The goal is usually to reduce monthly payments or pay off the loan faster.
Homeowners primarily refinance to lower interest rates and reduce monthly payments. Shortening the loan term or accessing home equity is very valuable or your overall financial health.
Does cashing out count as taxable gain?
A common misconception is that cash received from a cash-out refinance counts as profit or taxable income. However, this is not the case. The IRS considers the cash from a cash-out refinance as a loan, not income. Therefore, it is not subject to income tax. Essentially, you are borrowing against the equity you’ve built in your home, and loans are not considered income under tax law. For those who refinance simply to secure a lower interest rate or a different loan term (rate-and-term refinancing), there is no cash involved or gain involved besides a lower monthly payment. You are simply restructuring your existing debt.
Tax Implications of Refinancing
Deductibility of Interest
One of the benefits of refinancing is that the interest on the new mortgage can still be tax-deductible up to $10,000 for mortgage interest and property taxes.. This limit was updated after the 2017 Tax Cuts and Jobs Act. Today many homeowners do not get to fully deduct mortgage interest so paying less is obviously better.
Closing Costs and Fees
Closing costs, such as appraisal fees, title insurance, and attorney fees, are not tax-deductible. However, if you paid points to lower your interest rate, those points may be deductible over the life of the loan. It's essential to keep detailed records to maximize your tax benefits.
Capital Gains Consideration
Refinancing does not trigger capital gains taxes because it does not involve the sale of the property. However, if you sell your home at a profit, capital gains taxes may apply, if profit exceeds $250,000 (for a single person) or $500,000 (for a married couple filing jointly) on a primary home residence.
Debunking Common Myths
Myth 1: "Cash from a refinance is taxable income."
This is false. Cash received from a refinance is considered a loan, not income, and is not subject to taxation.
Myth 2: "Refinancing always complicates taxes."
While refinancing can affect your tax situation, it doesn’t necessarily complicate it. Understanding the rules and keeping good records can help you manage the tax implications effectively.
Myth 3: "Refinancing leads to capital gains."
Refinancing does not result in capital gains, but selling your home may result in cap gains. Consult a tax advisor!
