If you re-refinance a cash out refinance, can you then deduct the entire amount of interest, and not just the portion that was used to repay the original mortgage?

[Frank-Farrell]

I recently refinanced my 300K mortgage @4% for a 570K @3.25% to cash out 270k to pay down a 5.75% 270k mortgage on an investment property. I then found out I cannot deduct that additional 270k interest because it was a cash out refinance. If I re-refinance the 570k(@2.5% luckily) will it reset the clock(so to speak) and I can then deduct the interest on the entire 570k(including the exempt 270k) since there is no longer a “cash out” but a straight refi?

[Cynthiad66]

There are a few rules on what you can and cannot deduct when you take a cash-out refinance. Though you can use the money for nearly anything, you’ll need to use it for a capital home improvement in order to deduct your interest. IRS Publication 936 covers this in a little more detail. As a general rule, you need to make some kind of improvement to your home that increases the property’s value to deduct your interest. You usually can’t deduct the interest if you use the money for anything else, like paying off credit card debt or taking your dream vacation.

For tax years 2018 through 2025, you can only deduct the interest from the amount of your loan that was used to buy, build, or improve the home that it’s secured by.

If you’ve ever used part of this loan to pay for things other than this home, you cannot deduct the interest from that amount of the loan, even if the transaction didn’t take place this year.

Changes in tax law went into effect on January 1, 2018 with the Tax Cuts and Jobs Act (TCJA) that significantly affected the tax deduction for interest on a mortgage refinance loan. The rules aren't as generous as they were in 2017, so you might want to bring yourself up to date before you consider refinancing your mortgage unless you have a pressing need for the money.

Don’t worry, we’ll help figure out what amount of interest you can deduct.

Examples of common ways you might have used this money not on your home include:

• Making a down payment on a different home
• Funding improvements on a different home
• Making a payment on a different loan or debt
• Having miscellaneous large purchases

Example: John took out a home equity line of credit on his home on Tuberose Street for $40,000. He used $25,000 to remodel his kitchen and bathrooms in his Tuberose Street home, and $15,000 as a down payment on a second house on Snowdrop Lane. He can only deduct the interest he paid on $25,000 he used to improve his Tuberose Street home.

The majority of these changes are set to expire at the end of 2025 when the TCJA sunsets unless Congress reauthorizes the Act or renews certain aspects of the legislation.

[Frank-Farrell]

Thanks, but I knew that. The question was specifically if I re-refinance the entire amount. Now, the first refinance is paid off and a new loan is substituted. Does the same cash out rule apply, even though the loan is gone?

If yes, then does that mean a person who owns a home free and clear can never use it as collateral and deduct the interest?

[AmeliesUncle]

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@Frank-Farrell wrote:
 If I re-refinance the 570k(@2.5% luckily) will it reset the clock(so to speak) 

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No.

It has nothing to do with "cash out", it has to do with what the actual money was used for.

Money that was used to buy, build or substantially improve your personal home, that portion of the interest may be an Itemized Deduction on Schedule A.

Money that was used for a business (or rental property), that portion of the interest could be a business (or rental) deduction.

So in your situation, if you cashed out $270k to reduce pay down the "investment property", that $270k is essentially refinancing and is connected to that "investment property".  If by "investment property" you mean "rental property", then that portion of the interest is a rental expense. 

[doctorsprague]

I, too, took some cash out of my primary residence, and paid off a secondary residence (which my husband is living in due to his job location--so both houses are fairly "primary" in our reality).  The interest rate is better and it's only one loan so overall, it's an improvement. 

I understand that the interest on the cash out portion is not deductible unless it's spent on the primary residence.  I do have projects lined up, so SOME of the cash will go back into this house, but it's not done so I have no receipts and don't know the final total.  Should I file an extension, so that I can have these numbers?

Also, like the OP, I have thought about RE-refinancing.  Will that be possible in 2025, if this provision is sundowned?

Thanks!

[NCperson]

@doctorsprague - if you took cash out and you have not yet spent the money to improve your home, then the related interest is not tax deductible UNTIL you use the cash to improve your home 

it won't do you any good to file for an extension because for each day that has gone by since you cashed out,  the cash out portion isn't deductible in any event.  Spending the money later to improve your home won't solve the past

https://www.irs.gov/pub/irs-pdf/p936.pdf

see page 10 and the examples

also, as the loan amortizes, it's the cash out portion that is presumed to paydown first; if some of the cash out interest  is not tax-deductible, then over time a higher and higher percent of the interest becomes deductible

comes 2025, you can always refinance, but if Congress changes the law, they will just grandfather in the debt; I can't imagine they will force folks to refi.  However, and I have no crystal ball, I wouldn't bet on it.   Much of the 2007-2008 financial and housing crisis was caused by people cashing out their equity and the government, through the tax deductibility of the interest, encouraging it.  I don't they will encourage it again.

does that help?

[NCperson]

@Frank-Farrell - I appreciate this is an old post and I tried to read though it. 

the rules for investment property and your primary residence are different.  The interest for the investment property are covered by the rules for Schedule E while the personal residence interest are covered by the rules for Schedule A 

You did have a question about someone who owned their home free and clear.  Understand the IRS has a definition of 'acquisition debt' - that is the money you use to buy your home in the first place, plus money used to improve the home.   THAT related interest is what is deductible on Schedule A.  

If you own your home free and clear, and decide to borrower against that home, the interest is ONLY deductible if the money is used to improve the home.  if it is used for cars, vacations, the stock market, etc, it is not deductible.   You can use it as collateral, but the use of the cash out is the critical determining factor on whether it is deductible or not 

You always have to keep tract of the cash out that was not used to improve the home; but as the loan amortizes,  it is the principal related to the cashout that amortizes first.