Cash Out Refinance

[kevinr12240]

After entering the 1098 mortgage interest information, TurboTax asks about the history of this loan.  My current loan is a refinance (one of several over a 30+ year period).  I am unclear how to answer the next question: "Have you ever pulled cash out from this loan when you refinanced it?".  Does "this loan" refer only to the current loan or over the entire history of loans (original purchase and all refinances).  In my case, I had a cash out in one refinance in 2003.  When I enter "Yes," I end up paying more taxes, so it's important to answer this correctly.

[Vanessa · Accepted solution]

Yes, it refers to the entire history of the loan.  So you will need to calculate the amount that is strictly related to buying, building or substantially improving your home.  The interest on any portion that was used for any other reason is not tax deductible. 

Example of how to calculate this number is below. 

If you refinanced your home in 2003, with a balance on your mortgage of $225,000 and took out $75,000 to pay off debt. Your new balance was $300,000. The $225,000 is your original home purchase amount,  the $75,000 is not so that interest is not deductible. Your original home purchase price is now 75% of the mortgage balance.

If you refinance again a month later before making any payments (for easy math sake) and take out $400,000, of which you use $100,000 to buy a boat, you would only count 56% of the balance as your original home loan balance. (225,000/400,000=.5625) So with no other refinancing, your current loan balance is $300,000, you would only be able to deduct interest on 56.25% of the balance or $168,700 (300,000x .5625)

Now, if you used the $100,000 to build an addition onto your house instead of buying a boat with it, this would be counted as substantially improving your home, therefore the amount that would now have deductible interest would be 81.25% ((225,000+100,0000/400,000=.8125) In this situation, you would be able to deduct the interest on 81.25% of your current balance if there was no further financing. 

[kevinr12240]

This is VERY helpful.  The key is any new loan must substantially improve the home purchased by the original loan.  If I understand correctly, a refinance with a cash out to buy land for a second home and later a second mortgage to build that second home do NOT meet the requirement because these funds are not improving the home that is the collateral for the original loan.  Hence the interest on these is NOT deductible.  I would think the same applies to a refinance where one consolidates a first and second mortgage.  Only the first (original) loan interest would be deductible.  Could you please verify that I am correct in my understanding.  Thank you very much.

[stanleyrshapiro]

What if we refinanced, and took cash out AFTER the tax year that we're preparing the return for. Does that count? 

What if that money was put right back into principle?

[VictoriaD75]

You will report the transaction in the tax year in which it occurred. Interest related to cash out refinancing is not deductible, even if you later used it to pay down the mortgage. Interest is only deductible if the loan was used to "buy, build or substantially improve" the home that secures the loan.

[oliu612]

I'm dealing with this as well. After I said I did a cash-out refi, it asks "Since you first took out the loan, how much has been spent to buy, improve or build the home it's secured by?"

I did not use the extra cash for the home, but I should still be able to use the original loan amount (like in your example) so a portion of my mortgage interest will be tax deductible.

Do I enter the ending balance on the original loan for this then? As the money spent to buy the home? If I put in $0 it doesn't calculate the portion that is tax deductible... and say I don't qualify for any deductions (does not show up on my itemized deduction at all even though I paid over $20k in interests).

[JamesG1]

Some TurboTax customers are experiencing an issue with their home mortgage average balance. This can cause the home mortgage interest to be incorrectly limited.  This may be affecting your tax return.

Please sign up for email notifications when an update related to this issue is available.

See this TurboTax Help.

[oliu612]

That doesn't solve my problem since it's a cash out refinance. Please check my original message again. 

[MarilynG1]

@ oliu612 Yes, you can still deduct Mortgage Interest for the amount of the Original Loan you Refinanced with Cash Out.

If you have a Refi loan for 50K, for example, and paid off the original loan balance of 45K, and took 5K out for other stuff, enter it just that way.

Indicate you have a 50K loan, which 5K was cash out, so 45K was used to 'buy, build or improve' the home.  

Click this link for more info on Entering a Refi With Cash Out. 

[aintnothingleft]

Hi Vanessa,

I know this thread is a little old, but it's our first time to deal with this, as we refinanced in 2020. 

As far as 'substantially improving your home', I get it that it's the principal pay-off amount PLUS any money used to make improvements to the home. In our case, the principle that our new loan paid off was $392K. Our new loan via refinance was for $450K, so ~$58K cash out. 

My question is defining the additional money used to make physical improvements in addition to the principle pay-off amount. We got the proceeds from the refinance around Nov 1, 2020. Does this mean we can only include physical improvements to our home from that date through Dec. 31, 2020? Or does it include all upgrades to our home from Jan. 1 through Dec. 31st 2020? Or even all improvements to the home from the beginning of the original loan (2016 for us) through Dec. 31st, 2020? 

Finally, for our 2021 tax return (thinking ahead to understand things better), would we simply put in improvements done in 2021 alone or would it be cumulative from the beginning of the refinance (or original loan, depending on your answer to above)?

Thank you for clarifying this!

Best,

Nick

[AmyC]

No, the cash may have spent before and after the cash out, for the improvement. See the full rules at IRS | Pub 936

@aintnothingleft

[aintnothingleft]

Thank you, @AmyC!

[paulofoakland]

I have a cash out refinance to figure. I pulled all the records of the projects the money went for and entered them in to Turbo Tax last year or the year before... and would like to bring that information forward since it has not changed... but that does not seem to have happened when I imported my past Turbo Tax file. Is it in there and I just have not found it? or is this another TurboTax shortcoming to add to the list (sorry to be so sour but the "user experience" is getting rawer and rawer)

[AmyC]

Expenses do not carry forward as that is entered on a year by year basis. Your records would show your final numbers and percentages to be used moving forward. Once you know x% goes to Bldg A and y% to Bldg B then you just use those percentages each year.

[paulofoakland]

This does not conform to my understanding of the problem. 

Get a refinance mortgage for $200,000. Use 100,000 to pay off the prior loan and use 50,000 to fix the foundation and use 50,000 to do non-house things... Now 75% of the mortgage is deductible and 25% is not. Right?... 1 year passes. There have been no changes in the expenses paid out of the mortgage loan. The money is all allocated back in year one. So the 75% is still the applicable rate on whatever the interest expense was for the year.... another year passes. No new expenses against the mortgage because the money is long gone. The percentage calculation remains the same because it was about the use of money back in year 0 when the funds were received and the contract began. No?

Re-finding the records of the expenses from an ever-receding year to recalculate the ratio of house to non-house uses for funds over and over is not a good work plan. Better would be to hold that information in the worksheets, bring them forward year to year like the donation history and the various schedules and review them from there. Often I find that I am being conscripted at my cost to be a QA engineer for Intuit.