How Are Cash Out Refinances Taxed? [Tax Smart Daily 021]

Should you sell your rental property and take the tax hit or hold it and keep the cash flowing? Here's a real-life example of a rental that explains how cash-out refinances are taxed.
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[@jamespettinelli6953]

Great video. Refinancing 13 units in Dayton at the moment. My property manager was coaxing me to sell some of the properties, but I'd rather take out the equity through a refi and put it toward something else and continue to cash flow on the properties. They're worth about twice what I paid and by refinancing I wouldn't be hit with a tax burden. I would take a bit of risk that the property values would go down, but my margins are so good that the cash flow would continue to sustain me. Thanks for providing the most crucial bit of info I needed though, which that the cash out is not taxed. Makes sense since it's really a loan. Awesome video! Do more!

[@ebert4134]

When you made your first calculation in the video of 950 you typed in 650.. so your cash on cash is even better than you thought😎

[@TheRealEstateCPA]

Dang good catch!

[@phonglai00]

Great video! If you refinanced and took cash out to have a new mortgage of $182k, and then sold the house for $260k, What’s the capital gains that you would have to pay? Would it be based on the new mortgage and thus only $78k, or based on the original mortgage and thus be $172k of capital gains tax.

[@j10001]

He has a full video on this. It’s not based on either mortgage. It’s based on your original cost basis, the total depreciation you have taken, and the net selling costs.

[@beebeeboo5813]

Great video, Brandon. Starting to make time to watch your stuff more often and get a lot out of it. Warren Dazzio

[@TheRealEstateCPA]

Awesome, thank you!

[@scottfreitag6517]

Funny just had a client today that I advised consider max cash out as it is tax free and than gave him some ideas of what to do with cash to get good returns and not buy at height of market 💥💥

[@TheRealEstateCPA]

I need ideas too 🙏

[@kennethblacow4235]

Please share your ideas. I am looking at a cash-out refi right now.

[@mackki198]

I’m also doing a cash out refi. I was looking at buying a rental property but prices are a little high. What did you suggest as an alternative. I’m looking at investing in a mezzanine loan

[@CDE424]

if trhe rich refinance to aviod taxes and never sell the asset, how they pay the loans back. Is cash flow enough?

[@rman99]

Great video. Thx. Could you do one on the tax details per stage for a passive investor in a multifamily syndication? Say investor put in 100k, gets 10% pref return for 2 yrs, then gets principal + 5k refi proceeds, then gets ongoing 3% cashflow, then property sells at 5 yrs and investor gets 25k equity closeout.

[@TheRealEstateCPA]

Absolutely! Look for it next week.

[@ducbui5811]

Thank you. I realize I’m doing it all wrong. Can you make a video of the best banks or institution to refinance rental properties thank you

[@DanielApke]

Great video, as a fellow real estate investor this is not talked about enough. Just have to be careful about over leveraging and need to make sure you're still cash flowing after the refi. Would you recommend pulling the max amount of cash out of the property or staying around 70%?

[@TheRealEstateCPA]

That's a tough question as it all depends on your risk tolerance and financial circumstances. However, it doesn't hurt to be a bit conservative to ensure you don't overleverage. Some believe 60% is a good balance.

[@christianperez8461]

Hey Brandon my question is what are the tax implication when selling after? There are so many videos of “investors” out there saying Cash out refi because it’s tax free money, but none seem to talk about the risk of the property losing value after a market down turn as you mention. It seems that it would make more sense to cash out refi and then sell shortly after, say after 2-3 months. What is the tax implication if any since when you go to sell you would be paying the loan off with all the proceeds from the sale. Does the left over money from the refi loan become taxable?

[@TheRealEstateCPA]

A cash out simply reduces your equity. It will not impact the taxable gain calculation. If I take a $70k HELOC on a $100k FMV home, then when I sell a few months later I will only receive $30k equity (versus the full $100k because I previously cashed out $70k). From a taxable gain perspective, I sell at $100k and compare that to my adjusted basis (purchase price minus depreciation). Maybe i bought for $60k a while back, so I have $40k of taxable gain. That $40k of gain exists whether or not I cash out refinance as lending does not impact my cost basis of the property or what I can sell it for.

[@MotivLifter]

So you are saying that tax would be owed on the cash out refi when the property is sold? Therefor making a cash out refi simply a postponement in taxation, not an avoidance?

[@MotivLifter]

How long after the cash out do you have to hold the property to not owe tax? In other words, can you cash out right before a sale and avoid the capital gain tax on the cash out portion?

[@misterpotato5022]

This!!! Came here to understand the same question

[@j10001]

When you sell, your _tax_ on the gain is not affected by your mortgage amount. Mortgage is irrelevant to the taxable gain calculation. He has a video on how to calculate the tax. The mortgage does have to be repaid though, so yes, you’ll be paying back all the cash you just took out using the cash-out refinance.

[@orrd]

It's amazing to think that not long ago there were still places in the US where you can buy a house under $200k that rents for $1650. That just doesn't exist within 500 miles of here.

[@wealthintruth6227]

Think outside the box. .... Sorry for the cliche. I purchased a lot that had a house that burned. .... It was for 20k. It's in N CA. Rent on the lot is 700. It can be done... just be creative in the hustle

[@jakeoreskovich3722]

So if you did refinance this. After you finally do cash out and actually sell the property, the capital gain is taxed based off the original $91k purchase price correct? In other words if you refinanced at $182k then sold at $260k after, the tax is still on the gain between the $91k and the $260k not the new loan amount of $260k and $180k? Hopefully that make sense haha.

[@TheRealEstateCPA]

Hi Jake, thanks for leaving a comment. You are correct in that the eventual capital gain will be assessed based on the selling price and the $91k purchase price (minus depreciation, plus improvements). The refinance will not affect the gain calculation.

[@narindikoh120]

When you refi and now have a higher mortgage is all of that interest tax deductible regardless of what you spent the cash out money on?

[@anakjakarta677]

Good explaination. I took a cash out refinance from my primary house to buy investment property, can I deduct the morgage interest in my primary into schedule E form ?

[@j10001]

I believe no. You’re only allowed to deduct the mortgage interest for the part of the refi mortgage that is the same as the value that was remaining on the original mortgage. The rest above that (the cash out part) is not deductible, as I understand it. But as with many tax issues, no one will notice and confirm this for you unless you’re audited. 🤷🏻‍♂️ Actually that might be the rule for your own house. Not sure if it’s the same rule for rental properties.

[@PAID6159]

Theoretically, what would be your payment on the refi? If it's higher than your monthly rent you would have to raise the rent and risk losing the tenant and having a vacancy to fill. The numbers would have to work and that means you might have to leave equity in the property. Is that correct? I might refi one of my properties.

[@PAID6159]

My question was answered. I rewatched the video. several times.

[@hummervee3395]

When we refi, is the payment paid with taxed money? Say I refi and my payment I $1000/month. Rental income is $1500/month. Am I paying income tax on the $1500 and then writing off the entire payment or can I only write off the interest?

[@j10001]

Only the interest

[@nathangregory8357]

What if the property is held in an LLC, 2 members, taxes filed as a partnership. I've heard that if the cash out proceeds exceed your basis as a partnership member, then that excess can be a gain on your K-1. I'd love that not to be true, and trying to wrap my head around it.

[@TheRealEstateCPA]

You heard correctly, however a loan backed by real estate is considered "qualified non-recourse financing" and gives you basis to take deductions and distributions even if you didn't personally guarantee the loan. Example: - Contribute $100k, $100k capital account - Your share of the loan = $150k... considered "qualified non-recourse financing" if not personally guaranteed - Basis to take deductions and distributions against = $250k This is how GPs in syndicates are able to take tax deductions from bonus depreciation without putting much into the deal. Note: your operating agreement has to have specific clauses so don't run with this extremely simple example as a solid tax opinion. Touch base with a qualified tax advisor first.

[@nathangregory8357]

@@TheRealEstateCPA Thank you, appreciate that clarification.

[@brianho2560]

Is the interest expense from the cash-out loan fully deductible?

[@TheRealEstateCPA]

Depends on how you use the funds. You have to "trace" the loan proceeds to where you ultimately use them and then deduct the interest associated with that new activity.

[@elizabethtreynor4646]

@@TheRealEstateCPA If I use the cash-out funds to invest in an unrelated syndication (this is on my primary home btw not a rental), will that portion of the interest be tax deductible? I doubt it but curious Tx!

[@21public]

@@elizabethtreynor4646 I think tax treatment of interest expense deductability gets more complicated if some mortgage portion is associated with the original purchase and some portion pulled out for investing. My case was a little cleaner, but I'll share. Primary residence was paid for. I took all of the cash out proceeds from primary residence were invested in syndications. I traced the use of funds and associated interest expense to those investments, which enables the deduction of the traced interest expense against the syndications' K-1 report. I think if you use only some of your primary residence associated borrowing funds for investing, and some other uses, then the tax treatment gets more complicated. (I'm not a tax professional)

[@amalik009]

What about property taxes? Doesn’t a refinance trigger a recording with the county and a reassessment of your property value? I’m in California maybe this is specific to California

[@TheRealEstateCPA]

From my understanding, a refinance should not impact your home assessment. I'm not sure about CA specifically.

[@georgep19844]

@@TheRealEstateCPAhey great video. If the property is held in an LLC, is it tax free when you remove the funds out of the company into personal name and bank account?

[@kanutapretzelini8891]

What's the best way to pull cash out of a property with no mortgage attached? HELOC?

[@TheRealEstateCPA]

Probably.

[@j10001]

HELOC is hypothecated so is a version of a mortgage. Why are you avoiding a mortgage anyway?

[@HomesForSale999]

What about the strategy of NEVER selling the property. Do a cash out refinance and 10 years later doing it again, and again. At the end of your life, will your rental properties to your children and never pay capital gains nor recapture :)

[@TheRealEstateCPA]

This can be a powerful strategy. Many have dubbed it "buy, borrow, die".

[@angostura7797]

The presumption with all this is that you never have a major repair like a full roof replacement or a full remodeling, which do not guarantee that you can raise the rent to cover the cost.

[@Itsellasky]

refi cash out , then you just make 6 payments and refi again with no cash out once u pay it down. take the refi money and buy another house and repeat.

[@wealthintruth6227]

Infinite yields....

[@lakshmank3737]

If i do a cash out refi, turn around and sell it what is the Tax impact ?

[@TheRealEstateCPA]

A cash-out refinance won't be a factor in calculating the gain on sale... so no tax impact directly from the financing in this case.