A cash-out refinance is one of the few ways to pull five or six figures out of your house without selling it. You swap a $320,000 mortgage for a $400,000 one, the old loan gets paid off at closing, and roughly $78,000 lands in your bank account after fees. Then a reasonable question shows up: does the IRS want a piece of that?
Almost always, no. But the assumption that the cash is tax-free often hides the part that does matter, which is whether you can still deduct the interest on the bigger loan. Get that wrong and you either overpay at tax time or claim a deduction you can’t support.
The money you receive isn’t income, because it isn’t yours yet
A cash-out refinance is borrowed money. You owe it back with interest, so the IRS doesn’t count the proceeds as income. No 1099 shows up in January. Nothing about receiving the cash goes on your return.
It helps to contrast this with transactions that genuinely are taxable. Sell a rental property and you may owe capital gains. Withdraw $50,000 from a 401(k) and it’s ordinary income. Lose a home to a short sale with $80,000 of debt forgiven and the lender can issue a 1099-C for cancellation of debt income. A completed cash-out refinance doesn’t belong in that group, because you haven’t been relieved of anything.
Where the tax question really lives: the interest deduction
Before 2018, you could deduct interest on up to $100,000 of home equity debt no matter what you spent it on. That rule is gone. Under current law, interest on debt secured by your home is deductible only when the loan was used to buy, build, or substantially improve the home that secures it. The combined cap on that acquisition debt is $750,000, or $375,000 for married couples filing separately.
A cash-out refinance can qualify, but only in proportion to how much of the money goes back into the property.
A worked example makes it concrete
Say you refinance $450,000 at 6.5%. Of that, $350,000 retires the original mortgage and $100,000 comes to you. If the $100,000 pays for a new roof, a kitchen gut, and a basement finish, the whole loan is potentially acquisition debt and the full interest can be deducted if you itemize.
If that $100,000 instead pays off credit cards, buys a truck, and covers a wedding, the character of each slice is different. The $350,000 that replaced your original purchase loan keeps its old status. The $100,000 slice doesn’t. That’s about 78% of the loan, so on roughly $29,000 of first-year interest you’d be looking at around $22,500 deductible and $6,500 not.
The IRS calls this interest tracing, and it follows the money rather than the loan label. Moving cash through three accounts doesn’t blur the trail in your favor; it just makes it harder for you to reconstruct.
The ceiling is higher than the standard deduction for many households
A deduction you can’t use is worth nothing. Interest on a $450,000 loan at 6.5% runs about $29,000 in year one. For a married couple filing jointly, the 2025 standard deduction is roughly $31,500. Unless your other itemized deductions push you well past that number, the mortgage interest line may not change your tax bill at all. Run the arithmetic before you let a deduction justify a higher rate.
Three common uses of the cash, three different tax results
- Personal spending. Credit cards, car loans, tuition, medical bills, a vacation. None of it creates deductible interest, and the new debt simply joins your mortgage at mortgage rates.
- Improving the home. This is the clean case. Money spent substantially improving the property that secures the loan stays inside the acquisition debt rules. It also raises your cost basis, which lowers a future capital gain. If you’re still weighing loan structures, this breakdown of how a home improvement mortgage works is worth ten minutes before you commit.
- Business or investment use. Deductibility may move to a different part of the return. Money put into a sole proprietorship can be traced to Schedule C. Money invested in a brokerage account becomes investment interest expense on Schedule A, and it’s only deductible up to your net investment income unless you elect otherwise.
Using the cash to buy a rental or a second home
Take $120,000 out of your primary residence and use it as a down payment on a rental, and the tracing points toward the rental property. That interest is generally deductible against rental income rather than treated as home mortgage interest, which is often a better outcome. Buy a vacation home you and your family actually use instead, and the debt counts as home acquisition debt, but the $750,000 cap then has to cover both properties together. The financing choices here are wide enough that it’s worth reading up on how second home mortgages are structured in 2026 before you decide which property takes the debt.
Points, closing costs, and the fees people try to write off
Origination points on a refinance usually can’t be deducted in the year you pay them. They get spread ratably across the loan term, so $4,000 of points on a 30-year loan works out to about $133 a year. There’s an exception worth knowing: if part of the refinance funds improvements to the home, the points allocable to that portion can often be deducted in full in the year paid, provided you funded them with your own money rather than out of the loan proceeds.
Appraisal fees, title insurance, recording charges, and credit report costs aren’t deductible as interest. They get added to your basis. And if you refinance again later, any unamortized points from the old loan can generally be written off at that point.
Build the paper trail before the money leaves the closing table
Deductions get challenged years after the fact, when your memory of which $18,000 transfer paid for the addition is long gone. A little housekeeping at closing saves real money later.
- Park the cash-out proceeds in a separate savings account so transfers are easy to follow.
- Pay contractors directly from that account rather than through your everyday checking.
- Keep signed contracts, permits, invoices, and before-and-after photos.
- Save the Closing Disclosure showing the payoff amount and the cash to you.
- Write a one-page allocation note at closing: how much went to debt payoff, how much to improvements, how much elsewhere.
Details that catch people off guard
State rules don’t always follow federal ones. A handful of states cap or limit mortgage interest deductions differently, and some impose a mortgage recording tax on the new loan at closing that can run into the thousands on a large balance.
A refinance on its own rarely triggers a property tax reassessment, since no ownership changes hands, but a major renovation can in some jurisdictions. Retirees have an extra consideration: pulling equity out at 6.5% to cover living costs is an expensive way to fund a retirement, and there are alternatives worth comparing, including home equity options designed for retirement income that don’t require a full refinance.
When the math says no
If the deduction is the main argument for the loan, the argument is weak. You’d be paying 6.5% to 7% in interest to potentially save 22% to 24% of a fraction of it. A cash-out refinance earns its keep when it replaces genuinely expensive debt, funds improvements that add more value than they cost, or gets you a better structure overall.
Watch the rate you’re leaving behind. Trading a 3.25% mortgage for a 6.5% loan to extract $40,000 resets every remaining dollar of your balance at the higher rate. Watching where refinance rates are heading in 2026 is a better starting point than a lender’s mailed offer.
If the amount you need is modest, a home equity loan or HELOC leaves your first mortgage untouched and is often cheaper. And qualifying for the new loan is its own project; a walkthrough of how to qualify for a conventional refinance and compare offers will save you from a hard credit pull at the wrong lender.
Questions to put to your lender and your tax preparer
Ask the loan officer for the Closing Disclosure three days before signing and read the sections on points and prepaid interest. Ask your tax preparer two things before you close, not after: how much of this interest will I actually be able to use, and how should I document the money I spend on the house? If the answer to the first question is “probably none,” you’ve learned something valuable while you still have the option to walk away.