Real Estate Tax Calc
Refinancing does not affect depreciation
Depreciation is based on your cost basis in the property — what you paid, plus improvements — not on your equity or your loan balance. When you refinance, neither of those changes. The purchase price and capital improvements stay the same; so does the annual depreciation deduction. A cash-out refinance might put $100,000 in your pocket, but it does not reset the depreciation clock or change the annual deduction.
Cash-out proceeds are not taxable income
The cash you receive in a cash-out refinance is loan proceeds — debt you will repay with interest — not income. It is not reported on your tax return as income, and since it does not add to your cost basis in the property, it also does not increase future depreciation.
What does change: the interest deduction
Refinancing changes your mortgage interest deduction because your loan balance and rate change. Mortgage interest on a rental property is generally fully deductible against rental income on Schedule E. If you pulled cash out for personal purposes (a vacation, a car), the interest on that portion may not be deductible as rental expense — the IRS traces the use of refinanced proceeds. Funds used for the rental property (repairs, improvements, down payment on another rental) generally retain rental deductibility.
The interest-tracing rules in more detail
The deductibility of interest on a refinance follows the use of the proceeds, not the property securing the loan — this is the IRS "interest tracing" concept. If you refinance a $200,000 rental mortgage into a $300,000 loan and use the extra $100,000 to renovate that rental or buy another investment property, the interest on the full $300,000 is generally deductible against rental income.
But if you use the $100,000 to buy a personal car or take a vacation, the interest on that slice is personal interest — generally nondeductible — even though the loan is secured by the rental. You would deduct only the interest attributable to the original $200,000 of rental debt. Documenting where the cash went (a clean paper trail from the refinance to the expenditure) is what supports the deduction if the IRS asks.
Points and refinancing costs are amortized, not deducted at once
When you refinance a rental, any points you pay to obtain the new loan are not fully deductible in the year paid. Instead, they are amortized (deducted ratably) over the life of the new loan. On a 30-year refinance, $6,000 of points yields about $200 of deduction per year ($6,000 ÷ 30). This differs from points on a primary-residence purchase mortgage, which can often be deducted immediately.
One useful wrinkle: if you later refinance again or pay off the loan early, you can generally deduct the remaining unamortized points from the earlier refinance in that year. Other refinancing costs — appraisal, title, lender fees — are treated as costs of obtaining the loan and are also amortized over the loan term rather than added to the property's depreciable basis.
Refinancing costs do not add to depreciable basis
A frequent misconception is that refinancing fees increase the property's depreciable basis and thus future depreciation. They do not. Loan costs relate to financing, not to the property itself, so they are amortized over the loan term as a separate intangible — they never touch the building's 27.5- or 39-year depreciation schedule. Only the purchase and subsequent capital improvements affect depreciable basis.
This is why a cash-out refinance, no matter how large, leaves your annual depreciation deduction exactly where it was. If you use the cash-out proceeds to make a genuine capital improvement, that improvement adds to basis and is depreciated on its own schedule — but the improvement drives the added depreciation, not the refinance that funded it.
A worked example
You bought a rental for $300,000 (building basis $240,000) and have been depreciating it at $8,727 per year. After five years, the property is worth $420,000 and you owe $220,000. You do a cash-out refinance to a $315,000 loan, pocketing about $95,000 after costs, and pay $6,300 in points.
What changes: your depreciation stays at $8,727 per year — untouched. The $95,000 cash is not taxable. Your interest deduction is now based on the new $315,000 balance and rate, deductible to the extent you use the proceeds for the rental or another investment. The $6,300 in points is amortized at $210/year over the new 30-year term. If you instead spend $40,000 of the cash on a new roof, that roof is a separate 27.5-year asset adding roughly $1,455/year of depreciation on top of the existing $8,727.
Refinancing, equity, and the sale later on
Because a cash-out refinance does not change your basis, it also does not reduce the gain or recapture you face when you eventually sell. Your adjusted basis at sale is still original cost plus improvements minus accumulated depreciation — the loan balance is irrelevant to that calculation. It is entirely possible to owe more tax at sale than the cash you walk away with, because you have already extracted equity tax-free through the refinance and still owe recapture and capital gains on the full economic gain.
This is a feature, not a bug, of real estate: cash-out refinancing lets you access appreciation without triggering tax, deferring the tax bill to sale (or eliminating it via a 1031 exchange or a step-up at death). Just plan for the sale-year tax so a large recapture and capital-gains bill does not catch you short after the equity has already been spent.
Common refinancing tax mistakes
Watch for these: (1) assuming a cash-out refi resets or increases depreciation — it does not; (2) deducting refinance points in full in the year paid — for a rental refinance they are amortized over the loan term; (3) deducting all the interest when part of the cash was used personally — trace the proceeds; (4) adding loan costs to depreciable basis — they are a separate amortizable intangible; and (5) forgetting to deduct remaining unamortized points from a prior refinance when you refinance again or pay off the loan. Keep clear records of proceeds use and loan costs to support every position.
Rate-and-term versus cash-out refinances
The two common refinance types are treated the same for depreciation but differ on the interest side. A rate-and-term refinance simply replaces your existing loan with a new one at a better rate or different term, with no cash extracted. The full interest remains deductible against rental income because 100% of the proceeds went to pay off the old rental debt — there is nothing to trace.
A cash-out refinance pulls equity out, and only the portion of the new loan that refinances the old rental debt or funds new investment use keeps its rental-interest deduction. The portion traced to personal spending produces nondeductible personal interest. Neither type changes your depreciation, your basis, or triggers tax on the cash — the distinction matters only for how much of the new interest you can deduct.
The BRRRR strategy and tax-free equity extraction
Refinancing is central to the BRRRR approach (buy, rehab, rent, refinance, repeat), where investors force appreciation through renovation, then pull their capital back out with a cash-out refinance to buy the next property. The tax appeal is real: the extracted cash is not taxable income, and depreciation continues unaffected on the original basis, so you can recycle capital across a growing portfolio without generating a current tax bill.
The catch is the same deferred-tax reality noted above — the equity you extract is not "free," it is borrowed, and the underlying gain and recapture remain waiting at sale. Investors who chain refinances across a portfolio should track each property's basis and accumulated depreciation carefully, because a future sale (absent a 1031 exchange) can produce a tax bill larger than the remaining equity after all the cash-outs.
Refinancing a property held in an LLC or partnership
If your rental is held in an LLC or partnership, the same principles apply, but the distribution of cash-out proceeds to owners adds a wrinkle. Loan proceeds distributed to members are generally not taxable to the extent of their basis in the entity, and the debt can increase a member's basis (particularly for recourse or qualified nonrecourse debt), supporting tax-free distributions. Depreciation inside the entity is unaffected by the refinance.
However, distributions in excess of a member's basis can trigger gain, and the interest-tracing rules apply at the level of how the entity (or the member) uses the proceeds. Refinances involving multi-owner entities are where professional advice pays off, because the basis and debt-allocation rules are more intricate than for a single owner holding property directly.
Frequently asked questions
Does a cash-out refinance reduce my depreciation deduction?
No. Depreciation is based on your cost basis, not your equity or loan balance. A refi leaves both unchanged.
Is the cash from a cash-out refi taxable?
No — it is loan proceeds, not income. You will repay it with interest over the life of the new loan.
Can I deduct the points I paid to refinance my rental?
Yes, but not all at once. Points on a rental refinance are amortized (deducted ratably) over the life of the new loan. If you refinance again or pay the loan off early, you can generally deduct any remaining unamortized points that year.
Is all the interest on a cash-out refinance deductible?
Only to the extent the proceeds are used for the rental or another investment. Under the interest-tracing rules, interest on any portion used for personal purposes is nondeductible personal interest, even though the loan is secured by the rental.
Do refinancing costs increase my depreciation?
No. Loan costs relate to financing, not to the property, so they are amortized over the loan term separately and never add to the building's depreciable basis. Only capital improvements increase depreciable basis.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.