If you need to get your hands on some cash and you have home equity, you may consider a cash-out refinance. While you may enjoy the funds, when tax time rolls around, you may find yourself wondering if you have to include the proceeds from your cash-out refinance on your tax return.
Keep reading to find out what the IRS has to say about it.
The Good News
First, we have some good news for you – it’s not necessary to claim the money on your tax return. Even if you took out a few hundred thousand dollars, you don’t have to add it to your income on your tax return. If you are scratching your head wondering how you can get away with this income, keep reading.
When you take money out of your home’s equity, you essentially borrow from yourself. Another way to look at it is that you don’t change your net worth. When you take the money out of your home’s equity, you increase your assets, but at the same time, you increase your liabilities. Here’s an example:
Your home is worth $300,000. You have a $200,000 mortgage outstanding on it. This means you have $300,000 in assets and $200,000 in liabilities or a $100,000 net worth. If you take $25,000 out of that equity, you now have $325,000 in assets and $225,000 in liabilities or a $100,000 net worth. It all works out the same in the end.
Writing Off the Interest on Your Taxes
There’s more good news. You can write off the interest on your cash-out refinance as long as it’s on your primary residence. While the tax laws changed, they mostly pertain to home equity loans and HELOCs. What did change is the maximum amount of interest that you can write off on your taxes.
Before this year, you could write off the interest on loans up to $1,000,000. Today, that number decreased to the interest on just $750,000. That’s still a significantly sized mortgage, though. The difference now, though, is that the standard deductions are much higher than before. A majority of homeowners won’t itemize their deductions, which means the interest deduction may not even affect you.
When do you Pay Taxes on a Cash out Refinance?
Eventually, you have to pay taxes on your investment in your home and that’s when you sell it. You’ll pay taxes on what the IRS calls your capital gains. Now, this doesn’t mean you’ll pay taxes on the $25,000 that you took out directly. Instead, the IRS determines your total capital gains based on the amount that you paid for the home and its value today.
Using our above example, let’s say you originally bought the home for $150,000. Today it’s worth $300,000. You earned capital gains of $150,000 no matter how much you owe in mortgages right now. Over time, you earned $150,000 whether you will receive that exact amount in cash now or not. B
The good news is that there are exceptions. If you file your taxes as a single person, you can make up to $250,000 in real estate capital gains before you pay taxes on the remainder. If you file your taxes jointly, you can make up to $500,000 in capital gains before you pay taxes.
Overall, you don’t pay taxes on your cash out refinance proceeds. If you are lucky enough to make more than $250,000 (as a single person) or $500,000 (as a married couple) you will pay taxes on any amount you make above that number. Otherwise, you can tap into your home’s equity and not worry about what it will do to your tax liability.Click to See the Latest Mortgage Rates»