Cash Out Refinance on Mortgage - What can I deduct?

[jamesnj]

Hi, I did a cash out refinance in 2022. I had about $6,000 in closing costs. I used some of the funds to install a new roof to increase my home value, and converted a sun room into a home office. It was not useable before, but I totally renovated it to have flooring, heating, cooling, new windows, etc.

What can I deduct from my taxes for 2022? I am trying to get a sense of what I owe or my refund.

[NCperson]

@jamesnj - As long as all the cash-out was used to improve / extend the life of your home, all the interest is tax deductible.  if you didn't plow all the cash-out back into the house, some of the interest would not be deductible (I'll explain how that works in a future post of that is the case).  

All the improvements you made adds to the cost basis of your home.  When you sell that will reduce the capital gains and any potentially tax.  

the closing costs are normally not tax deductible.  if there was interest on the closing statement, that would be deductible. 

[jamesnj]

@NCperson I pumped all of it back into the house actually. I paid various contractors though and don't have receipts for everything. Will I get audited if I don't have the receipts? Some were paid cash, some check, etc. I do have before and after pictures of course.

To elaborate, I got $21,804.03 from the cash out refinance and used every cent to build the office, new roof, and made major improvements to the dining room area with new flooring and raised ceiling. This was not a purely cosmetic thing like slapping new paint on.

Let me know what you think and how does that work? e.g. how do I deduct the $21,804.03 - I assume it is a fraction of that

[NCperson]

@jamesnj 

1) maintain the records, including canceled checks or bank statements / credit cards to document the transactions.  the cash items, just write it down on a piece of paper how much and who you paid.  years from now when you finally sell it may not make a difference.  

2) NOTHING is deductible NOW.  what ever you invested in the house adds to the 'cost basis'.  Cost basis is the original purchase price PLUS what you plowed back into the house that improved and extended the life of the house.  it'll reduce the gain whenever you sell and will be reflected on your tax return at that future date.

3) none of the $21,804 is deductible, but all the interest you pay continues to be deductible (if you itemize your deductions). 

think of it this way, the IRS is not going to incent taxpayers to cashout refi their home (the $21k); we'd be back in the financial crisis of 2008 if that was permitted! 

does that make sense? . 

[jamesnj]

Yes that makes sense, thanks for the explanation.