Taxes on a mortgage loan for cash

Scott,

Thanks for the question. Your loan will be called a cash-out refinance even though you are not replacing any current financing. Since you paid cash for the property you can obtain the loan even though you may have owned it less than six months with a ‘Delayed Financing Exception’. You cannot borrow more than the amount of your investment to acquire the property. If you purchased a property with financing you cannot get cash-out until after six months has elapsed from the purchase.

Regarding the tax implications you should consult your tax advisor and lender for advice specific to your situation. I think you will find that money obtained through a loan is not considered a capital gain, earned income, or any other form of income and therefore will not be subject to any form of income tax. Some states have fees (taxes) that are required to be paid when a mortgage is recorded. In New York and Florida these recording fees can be substantial. If I remember correctly California will have a modest fee for recording the security instrument on the new loan, but the transfer tax was paid when you purchased the home.

Information regarding Federal income tax deductibility of the interest can be found here: IRS Publication 936 If your home is a main home or a second home the interest on the mortgage debt may be deductible, but there are limitations.

Note the section on “Fully Deductible Interest” where it says “How much you can deduct depends on the date of the mortgage, the amount of the mortgage, and how you use the mortgage proceeds.” If a mortgage loan is not used to aquire the property it will be considered “home equity debt.” The qualified loan limit for home equity debt is $100,000 ($50,000 if married filing separately.)

You will want to pay close attention to “Part II” where it explains that the qualifed loan limit for home acquisition debt is $1,000,000 ($500,000 if married filing separately.) If you are going to borrow more than $100,000 you can see that it is advantageous that your mortgage debt is considered home acquisition debt. Even though you paid cash for the home it is possible for a mortgage to be considered home acquisition debt. In Part II it says, “A mortgage secured by a qualified home may be treated as home acquisition debt (if)….You buy your home within 90 days before or after the date you take out the mortgage. The home acquisition debt is limited to the home’s cost, plus the cost of any substantial improvements….” Also note in Publication 936 the definition of “Date of the Mortgage.”

As you can see this can get complicated and due to the importance of getting it right you need to contact a CPA or other competent tax advisor.