Tax on cash-out from refi

[popadoc45]

Hi, I just closed on refinancing home and I cashed-out some of my equity. The mortgage company deposited a little over $12,000 into my checking account. I know banks have to report deposits over $10,000 to the IRS.

Is this going to cause a problem for me with the IRS? Do I have to pay taxes on ''cash''from the equity in my home received from just refinancing my home?

[Mike9241]

assuming this was your first or second home.  the only tax issue that arises is that if you refi'd for more than the mortgage balance the excess unless used to substantially improve the property or possible for some other non-personal purpose is not te=reated as mortgage debt and the interest paid on that portion is not deductible.

[TomD8]

Q: "Do I have to pay taxes on ''cash'' from the equity in my home received from just refinancing my home?" 

No.  The IRS doesn’t view the money you take from a cash-out refinance as income – instead, it’s considered an additional loan.   But, as @Mike9241 pointed out, there are certain rules you must follow in order to claim the mortgage interest deduction.

[rjs]

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@popadoc45 wrote:

I know banks have to report deposits over $10,000 to the IRS.

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Banks have to report deposits of $10,000 or more in cash, meaning actual currency. The mortgage company probably made an electronic deposit, or deposited a check. That's not what's meant by "cash" for reporting requirements. The deposit will not be reported to the IRS.

[Opus 17]

Borrowing money is never taxable income (regardless of whether it is reported) because it's not income--if you promise to pay the money back, it's not really your money.  However, if you default on the loan or it is forgiven by the lender, it does become taxable income at that time, since you don't have to repay it anymore and it is now your money. 

[Carl]

Is this going to cause a problem for me with the IRS?

Short answer - No.

Borrowed money is not your money. Never was. Is not now. Never will be so long as you pay it back as agreed.

[NCperson]

@popadoc45 - while I agree with all stated by others, the issue isn't with the cash-out being taxable, the issue is how much of the interest is tax-deductible going forward

if that $12,000 is being used to substaintially improve that same home, then the interest on the $12,000 is going  to be deductible,

but if you are just pocketing the money and not re-investing it back into your home. the related interest is not deductible.  As the new loan amortizes down, this first $12,000 is paid back first, so it won't be that many years of determining the non-deductible portion of the interest. 

[fanfare]

"As the new loan amortizes down, this first $12,000 is paid back first, "

Where do you get that idea?

Your deductible Interest is prorated for other purposes, v.s. home-related purposes, from year one.

@NCperson 

[Carl]

As I've always understood it, the percentage of the interest equal to the percentage of the refi used to pay off the prior loan, is what is deductible over the life of the new loan.  That percentage of deductible interest can increase, even at a later date, all the way to 100%, depending on what the cash out amount is used for.

[NCperson]

@fanfare @Carl 

 Pub 936 page 10:  

Refinanced home acquisition debt. Any secured debt you use to refinance home acquisition debt is treated as home acquisition debt. However, the new debt will qualify as home acquisition debt only up to the amount of the balance of the old mortgage principal just before the refinancing. Any additional debt not used to  buy, build, or substantially improve a qualified home isn't home acquisition debt."

“Figure the balance of that category of debt for each month. This is the amount of the loan proceeds allocated to that category, reduced by your principal payments on the mortgage previously applied to that category. Principal payments on a mixed-use mortgage are applied in full to each category of debt, until its balance is zero, in the following order. a. First, any home equity debt not used to buy, build, or substantially improve the home. b. Next, any grandfathered debt. c. Finally, any home acquisition debt.”

Further, please look at the discussion of mixed used mortgage page 13 (Pub 936) – 2nd column and continuing with Example 1 and Example 2 in the next column. In Example 1, all the principle payments go against the Home Equity debt first and once that is extinquished (Example 2), only then against the Acquisition debt.  

There is no proration of the amortization (which is what I think you were suggesting???); there is a prioritization where all the principle payments reduce the home equity debt not used to improve the home first.

[fanfare]

 Glad to see Carl chiming in since my understanding was based on his answer to this problem earlier !

[fanfare]

your quotations from 936 are not very consistent with the "Mortgage Interest Deduction Limitation Worksheet", there is no  mention of category of debt priorities. See Line 14 of the worksheet.

@NCperson 

[Mike9241]

another thing is it's not the interest on the $12K that won't be deductible it's actually the interest on the increase in the mortgage balance. when you refi the mortgage balance increases by $X but from that $X amounts are usually deducted to pay the closing and other costs. see @NCperson answer.

[NCperson]

@fanfare - mortgage interest can be non-deductible for two reasons

1) it can be non -aquisition debt which was not used to improve the residence.  As discussed above, the related principle amortizes first

2) the balance of aquisition debt exceeds a cap.  Depending on the date the money was borrowed, this cap is $1,000,000 or $750,000.  The Mortgage Interest Limitation Worksheet determines how much of the aquisition interest is dedutible should the cap be breached.  Note further that Line 14 is dependent on Line 11 divided by Line 12.  Line 11 is the aquisition debt limit. Line 12 is the total amount of aquisition debt.  Line 13 is the interest paid on aquisition debt.  The worksheet has nothing to do with debt or the related interest that is non-aquisition debt - THAT is why there is no mention of debt priorities.  

[Carl]

One thing I see, particularly in the examples, is the use of grandfathered debt incurred prior to October 14, 1987. I really haven't seen much of that in these forums this year. But it's use tends to confuse things (at least for me) and produces contradictions. If I just ignore grandfathered debt and go on the presumption all debt was established after Oct 14, 1987 then the way I understand it, is that the percentage of interest that is deductible is equal to the percentage of the loan balance that was refinanced, plus the percentage of the refi that was used to buy, build or improve the home.

As I understand it, it's perfectly possible for the percentage of deductible interest to increase say, 2 years later if at that time you use the cash out money to improve the home. But until then, the percentage does not change.

Now with grandfathered debt that's a different story, and a story that I'm having a hard time grasping in it's entirety. But the reason I'm not worrying about it all that much is because at this time grandfathered debt would be well over 30 years old. (33 years as of Oct 2021). I figure a majority of those homes originally refinanced in or before 1987 would have been sold under a new mortgage by now. Though I do recall seeing one (and only one) where the home was originally purchased prior to 1987. But even that one the refi amount including the cash out, was well below $750K. So for that one the rules as they applied to the grandfathered debt part, didn't seem to change anything of any significance.