Cash-Out Refinance Tax Implications

A cash-out refinance can give real estate investors access to the equity in a rental property without having to sell it. You replace the current mortgage with a larger loan and receive the extra amount in cash. Since that money has to be repaid, the refinance proceeds themselves generally aren’t considered taxable income.

Where things get more important from a tax standpoint is what you do with the money. Interest on the additional borrowing may be deductible when the funds are used for investment purposes, such as purchasing another rental or improving an existing property. Using the cash for personal expenses can produce a very different result, which is why keeping a clear paper trail is so important.

A refinance also doesn’t reset the property’s depreciation or increase its tax basis simply because the property is worth more today. If some of the borrowed funds are used for qualifying improvements, however, those new improvements may create additional depreciation opportunities. Loan fees and other refinancing costs can have their own tax treatment as well, so they shouldn’t automatically be treated as an immediate deduction.

For investors, the bigger question is whether pulling out equity helps move the portfolio forward without putting too much pressure on cash flow. Before refinancing, consider where the proceeds will go, whether the property can comfortably handle the higher debt payments, and how the transaction fits your long-term investment plan. It’s also worth reviewing the plan with your tax advisor before closing so the use of the funds and related records are handled properly from the start.