Key Takeaways:
- Experts agree that the money you receive from a cash-out refinance is not considered taxable income because it’s a loan, not earnings.
- You may be able to deduct mortgage interest on the refinanced loan if the funds are used for qualified home improvements.
- Other home equity options can have different tax implications, so it’s important to compare your options before borrowing.
If you’re sitting on a sizable amount of home equity, a cash-out refinance can be a good way to turn those funds into usable cash. But you may be wondering: Do you have to pay taxes on home equity cash-out funds?
The short answer is no, these funds are not considered income, but like most things related to taxes, there are nuances involved. Depending on how you use the money and the type of financing you choose, there could be tax deductions available. Let’s look at the cash refinance tax implications, how it compares to other home equity options, and the pros and cons of this strategy.
What Is a Home Equity Cash-Out Refinance?
A cash-out refinance replaces your existing home loan with a new, larger mortgage, and you pocket the difference in cash. For example, if your home is worth $400,000 and you owe $200,000 on your mortgage, you might refinance into a $280,000 loan. After paying off the $200,000 balance, you’d walk away with $80,000 in cash (minus closing costs).
Homeowners can use these funds to pay for home renovations or upgrades, consolidate high-interest debt, or cover other major expenses. But because the funds come from equity you already own, many borrowers wonder whether tapping into that equity triggers taxes.
Is a Cash-Out Refinance Taxable?
The funds you receive from a cash-out refinance are not taxable income because they’re considered loan proceeds, not earnings. You’re borrowing against your home’s equity and agreeing to pay the money back with interest. Since the funds must be repaid, they don’t count as income and won’t appear on your tax return.
That also means you won’t face an immediate tax liability simply for accessing your home equity via a cash-out refinance. The proceeds are treated as debt, not income, so you won’t owe federal income tax at the time you refinance.
However, if your lender forgives some or all of your loan balance, that forgiven portion may be considered taxable income by the IRS. So while the cash-out funds themselves are not taxable, how you use the money and the circumstances around repayment can create tax consequences later on.
Can a Cash-Out Refinance Help at Tax Time?
Although the cash itself isn’t taxable, a cash-out refinance can still influence your taxes, mainly through the mortgage interest deduction. According to IRS Publication 936, homeowners can deduct interest on loans used to make home improvements. So if you use your cash-out funds to renovate your kitchen or replace a roof, the interest on that portion of your loan may qualify as deductible.
On the other hand, if you use the money for personal reasons, like paying down credit card debt or taking a vacation, the interest is not deductible. The IRS makes a clear distinction between debt used to improve your home and debt used for personal expenses. It’s also important to be aware of broader limitations in place. The Tax Cuts and Jobs Act (TCJA) capped the mortgage interest deduction at $750,000 of total mortgage debt for loans originated after December 15, 2017. In addition, homeowners must keep careful records to show that the cash-out proceeds were used for qualifying improvements if they want to claim the deduction.
This means that while a cash-out refinance can’t directly reduce your taxable income, it can provide tax benefits if the funds are applied strategically toward your home.
Tax Implications vs. Other Ways to Access Home Equity
A cash-out refinance is just one of several ways you can access the equity in your home. Other options carry similar, but slightly different, tax implications.
A home equity loan works like a second mortgage with a fixed interest rate and predictable monthly payments. Because it’s a loan,7 the interest is deductible only if the funds are used to buy, build, or improve your home.8
A home equity line of credit (HELOC) functions more like a credit card secured by your house, and it provides a revolving line of credit that you can draw from as needed. Like the two options above, interest may be deductible for home improvements, but not for personal uses.
Finally, there are home equity agreements (HEAs), where an HEA provider like Unlock gives you a lump sum in exchange for a share of your home’s future value. However, same as with any financial product, you should consult a tax and financial professional to understand how the unique structure of an HEA could impact your tax situation.
The pros and cons of refinancing a home with a cash-out mortgage
Pros
- Large lump sum: A cash-out refinance comes with a large lump-sum payment, and often at lower interest rates compared to personal loans or credit cards.
- Potential tax deductions: A portion of your mortgage interest may be deductible if the funds are used for home improvements.
- Debt consolidation benefits: A cash-out refinance can be a good way to replace high-interest debt with lower mortgage rates.
Cons
- Closing costs: You’ll have to pay closing costs, which are typically 2%–6% of the total loan amount and reduces your net payout.
- Risk to your home: By refinancing, you’re increasing your mortgage balance, and default could lead to foreclosure.
- Longer repayment term: Taking out a new mortgage could cause you to pay more in interest over time.
Conclusion
So, is a home equity cash-out taxable? Generally, no, since the cash you receive is a loan, not income. But how you use the funds can impact whether your mortgage interest qualifies for deductions at tax time.
If you plan to renovate your home, a cash-out refinance comes with potential tax advantages. If you’re considering using the funds for other purposes, it’s important to weigh the costs, risks, and alternative financing options carefully.
Ultimately, the right decision depends on your financial goals, how long you plan to stay in your home, and whether the benefits outweigh the potential drawbacks.
