You do not owe taxes on a cash-out refinance. The money you take out at closing is borrowed, not earned, so it never shows up as income on your federal return no matter how large the check. The real tax question with a cash-out refinance is a different one: whether the interest you pay on the bigger new loan is deductible, and that depends almost entirely on what you do with the cash.
Why the Cash Isn’t Income
A cash-out refinance replaces your existing mortgage with a larger one and hands you the difference. Because you have to pay every dollar back with interest, the IRS does not treat those proceeds the way it treats wages, dividends, or a sale. Loan proceeds sit outside the federal definition of gross income.1Office of the Law Revision Counsel. 26 USC 61 – Gross Income Defined The size of the cash-out and the reason you took it do not change that answer.
What Determines Whether the Interest Is Deductible
Federal law lets you deduct “qualified residence interest,” which covers interest on debt used to buy, build, or substantially improve your main or second home. That category is acquisition indebtedness.2Office of the Law Revision Counsel. 26 USC 163 – Interest
The portion of the new loan that simply pays off your old mortgage balance keeps its status as acquisition debt. The extra cash you pull out is different. That new money only counts as acquisition debt if you spend it on substantial improvements to the home securing the loan. Spend it on anything else and the interest on that slice is generally not deductible as mortgage interest.
A worked example: you refinance a $300,000 mortgage into a $450,000 loan and pocket $150,000. Interest on the first $300,000 stays deductible as before, assuming you itemize. Interest on the $150,000 depends on where the money goes:
- A kitchen remodel or a new roof: deductible, because those are substantial home improvements.
- Paying off credit cards or buying a car: not deductible as mortgage interest. Personal interest has been non-deductible since 1991.
- Business capital or buying investments: potentially deductible, but not as mortgage interest. Interest tracing rules apply.
Your lender sends a Form 1098 showing total interest paid without breaking it out by how you used the money.3Internal Revenue Service. Form 1098 – Mortgage Interest Statement Figuring out the deductible portion is on you.
The $750,000 Cap on Deductible Mortgage Debt
Even when cash-out proceeds qualify as acquisition debt, there is a ceiling. For mortgages taken out after December 15, 2017, you can deduct interest on up to $750,000 of acquisition indebtedness ($375,000 if married filing separately). The Tax Cuts and Jobs Act set that cap, and later legislation made it permanent.2Office of the Law Revision Counsel. 26 USC 163 – Interest
Mortgages originated on or before December 15, 2017 fall under an older $1,000,000 cap ($500,000 if married filing separately). If you refinance a grandfathered loan without pulling cash out, the higher limit carries over. But with a cash-out, only the portion replacing the old balance keeps that treatment. The new cash-out portion falls under the $750,000 rule.4Internal Revenue Service. Publication 936 – Home Mortgage Interest Deduction
You Have to Itemize
Mortgage interest is an itemized deduction. It only helps if your itemized total on Schedule A beats your standard deduction. For 2026, the standard deduction is $16,100 for single filers, $32,200 for married couples filing jointly, and $24,150 for heads of household.5Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Mortgage interest, state and local taxes (capped at $10,000), charitable gifts, and other allowed items need to add up to more than that before the deduction produces any real benefit. Homeowners with smaller balances often find the tax savings from a cash-out refi are smaller than they expected. Run the numbers first.
Cash-Out for a Business or Investments: Interest Tracing
Using cash-out funds for a business or to buy investments does not kill the interest deduction. It reroutes it. Federal regulations require you to trace the debt to what you actually spent the money on, and the interest follows the expenditure.6eCFR. 26 CFR 1.163-8T – Allocation of Interest Expense Among Expenditures
- Business use. Interest becomes business interest, deducted on Schedule C or the business return rather than Schedule A.
- Investment use. Interest becomes investment interest, deductible up to your net investment income for the year under Section 163(d).
- Personal use. Interest becomes non-deductible personal interest.
The security for the loan and the use of the proceeds are separate questions. A loan secured by your house does not automatically generate a mortgage interest deduction. What matters is where the money went.
The 30-Day Timing Rule
Tracing is easier when spending happens close to closing. Treasury regulations give you a 30-day window on each side: an expenditure made within 30 days before or 30 days after you receive the proceeds can be treated as made from those proceeds.7eCFR. 26 CFR 1.163-15 – Debt Proceeds Distributed From Any Taxpayer Account or From Cash Outside that 60-day window, funds sitting in your account are treated as held for investment, and the interest becomes investment interest for the period the money sat idle. If you plan a renovation, pay the contractor within 30 days of closing rather than letting the money linger in savings for months.
Points and Other Closing Costs
Points on a refinance generally cannot be deducted in full the year you pay them. You spread the deduction evenly over the life of the loan, so one-thirtieth per year on a 30-year mortgage.8Internal Revenue Service. Topic No. 504 – Home Mortgage Points There is a narrow exception: if part of the refinance goes toward improving your principal residence, you can deduct the share of the points tied to that improvement in the year paid, provided the points meet the standard IRS criteria (computed as a percentage of the loan, customary for your area, clearly identified on the settlement statement).
If you refinance again before the loan term ends, any unamortized points left from the old loan become deductible in that year.
Appraisal fees, title insurance, attorney fees, and other non-interest charges on a refinance are not deductible in the year paid.9Internal Revenue Service. IRS Tax Tip 2003-32 – Refinancing Your Home They generally cannot be added to your home’s cost basis either.10Internal Revenue Service. Publication 551 – Basis of Assets For most refinance closing costs, there is no direct tax benefit.
Mortgage Insurance Premiums
A cash-out that raises your loan-to-value above 80% usually brings private mortgage insurance with it. For 2026, the federal deduction for mortgage insurance premiums is available again. You can deduct PMI as an itemized deduction if your mortgage balance is $750,000 or less and your adjusted gross income falls within the limits. The deduction phases out for single filers with AGI above $50,000 (gone at $54,500) and joint filers above $100,000 (gone at $109,000). It covers conventional PMI and mortgage insurance on FHA, VA, and USDA loans.
If the Debt Is Later Forgiven
The proceeds themselves are not income, but forgiven debt is a different story. If you default and the lender cancels part of what you owe, the canceled amount is generally taxable, and the lender issues a Form 1099-C for any cancellation of $600 or more.11Internal Revenue Service. About Form 1099-C, Cancellation of Debt
For years, a Section 108 exclusion let homeowners exclude up to $750,000 of forgiven debt on a principal residence. That exclusion expired at the end of 2025 and does not apply to debt discharged in 2026 or later.12Internal Revenue Service. Publication 4681 – Canceled Debts, Foreclosures, Repossessions, and Abandonments Other exclusions still exist, notably insolvency (your total debts exceed your total assets at the time of cancellation), but the broad principal-residence exclusion is gone.13Office of the Law Revision Counsel. 26 USC 108 – Income From Discharge of Indebtedness
That matters more with a cash-out because you have raised your total debt. Pull out $150,000, spend it, then face foreclosure where the lender forgives a slice of the balance, and you can end up owing income tax on money you no longer have.
Effect on Capital Gains When You Sell
A cash-out does not trigger capital gains tax on its own. Borrowing is not a sale. But how you spent the cash can change the math when you eventually sell.
Money spent on qualifying home improvements increases your cost basis, which reduces the taxable gain at sale. Most homeowners already exclude up to $250,000 in gain ($500,000 for joint filers) under Section 121 if they owned and lived in the home for at least two of the five years before the sale.14Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence For homes that have appreciated well past those limits, documented improvements can meaningfully shrink the taxable slice above the exclusion.
Cash spent on anything other than the home leaves your basis unchanged. Save receipts and contractor invoices; they support the interest deduction now and a higher basis later.
Records to Keep
Every tax rule that applies to a cash-out refinance rests on documentation. Your lender does not track how you spent the money, and the IRS will not assume the favorable treatment applies. Hold on to:
- The closing disclosure, which shows the exact cash-out amount and all closing costs.
- Contractor invoices and receipts, which prove funds went to home improvements.
- Bank statements, which show the timing needed for the 30-day tracing safe harbor.
- Form 1098, remembering that the total interest shown may not all be deductible.
If the cash-out was split between home improvements and other spending, you will need to allocate interest between deductible and non-deductible portions each year. Setting that up correctly the first year, with a tax professional if the numbers are large, makes every year after it routine.