Is a cash-out refinance of rental property tax-deductible?

When it comes to taxes and rental property, things can get a bit complicated. One common question that many landlords have is whether a cash-out refinance of rental property is tax-deductible. The short answer is yes, but with some limitations and considerations.

One of the biggest benefits of owning rental property is the ability to deduct a wide range of expenses from your taxable rental income. These expenses can include mortgage interest, property taxes, repairs, maintenance, and more. When you refinance a rental property and take cash out, the interest you pay on the new loan is generally tax-deductible, just like the interest on the original loan.

However, there are some important caveats to keep in mind. The interest on the cash-out portion of the refinance is only tax-deductible if the money is used for a qualifying purpose related to the rental property. This could include making improvements to the property, paying for maintenance or repairs, or even purchasing another investment property. If the cash-out funds are used for personal expenses or unrelated investments, the interest may not be tax-deductible.

It’s also important to note that there are limits on the amount of mortgage interest that can be deducted on rental properties. The Tax Cuts and Jobs Act of 2017 placed a cap on the amount of mortgage interest that can be deducted on rental properties, limiting the deduction to interest on the first $750,000 of mortgage debt for married couples filing jointly ($375,000 for individuals).

In addition, if the cash-out refinance results in a larger mortgage than the original loan, the interest on the portion of the loan that exceeds the original mortgage amount may not be fully tax-deductible. This is known as the “acquisition indebtedness” rule and could further limit the tax-deductibility of the refinanced loan.

In conclusion, a cash-out refinance of rental property can be tax-deductible, but it’s important to carefully consider how the funds will be used and to understand the limitations on deductibility.

FAQs about cash-out refinance of rental property and taxes:

1. Can I deduct the interest on a cash-out refinance of a rental property if I use the funds for personal expenses?

No, the interest on a cash-out refinance is only tax-deductible if the funds are used for qualifying rental property purposes.

2. Are there limits on the amount of mortgage interest that can be deducted on rental properties?

Yes, the Tax Cuts and Jobs Act of 2017 placed a cap on the amount of mortgage interest that can be deducted on rental properties.

3. Does the “acquisition indebtedness” rule apply to cash-out refinances of rental properties?

Yes, if the cash-out refinance results in a larger mortgage than the original loan, the interest on the portion of the loan that exceeds the original mortgage amount may not be fully tax-deductible.

4. Can I deduct expenses related to the cash-out refinance, such as closing costs or appraisal fees?

No, expenses related to the cash-out refinance itself are generally not tax-deductible.

5. Can I deduct the interest on a cash-out refinance of a rental property if I use the funds to purchase another investment property?

Yes, as long as the funds are used for a qualifying investment purpose, the interest on the cash-out refinance may be tax-deductible.

6. Are there any restrictions on the types of improvements or repairs that the cash-out funds can be used for?

The improvements or repairs must be related to the rental property and can’t be for personal use in order for the interest to be tax-deductible.

7. Can I deduct the interest on a cash-out refinance of a rental property if I use the funds to pay off credit card debt?

No, the interest on the cash-out refinance may not be tax-deductible if the funds are used for personal expenses or debts.

8. Do I need to keep records of how the cash-out funds were used in order to claim the tax deduction?

Yes, it’s important to keep detailed records of how the cash-out funds were used in case of an audit by the IRS.

9. Can I deduct the interest on a cash-out refinance if I own the rental property through a partnership or LLC?

Yes, as long as the interest is related to the rental property and the funds were used for a qualifying purpose, the deduction should still apply.

10. Are there any tax implications for refinancing a rental property with a higher interest rate?

Refinancing with a higher interest rate could increase your expenses and reduce your net rental income, potentially affecting your overall tax liability.

11. Can I deduct the interest on a cash-out refinance of a rental property if I use the funds to take a vacation?

No, the interest on the cash-out refinance is only tax-deductible if the funds are used for qualifying rental property purposes.

12. Can I deduct the interest on a cash-out refinance of a rental property if I use the funds to pay off student loans?

No, the interest on the cash-out refinance may not be tax-deductible if the funds are used for personal expenses or debts unrelated to the rental property.

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