If I re-fi an investment property and pull out 15K do I pay gains on that event? It would be less than two years of ownership if that makes a difference.
Nate-WI
Refi has no effect on the gain of the property. You determine your gain when you sell the property. You may also be able to deduct the interest depending on what you use the cash in the re-fi for.
For holding purposes a sale under a year is considered short term gains that are taxed at your tax rate and over a year is long term capital gains which is about 15% or lower depending on your tax bracket. A 1031 exchange avoids paying gains til you ultimately sell or die…
A cash-out refi is borowing of money. You do not pay tax on borrowed money.
Keith
Thank you as always Keith.
Nate-WI
I had a client last year who cashed out about 12 properties and sold them 6 months later. Not sure if he successfully avoided showing a profit and avoiding taxes, but he kept telling me how smart he was for doing this.
I had a client last year who cashed out about 12 properties and sold them 6 months later. Not sure if he successfully avoided showing a profit and avoiding taxes, but he kept telling me how smart he was for doing this.
What he cashed out has nothing to do with “showing a profit” and little to do with “avoiding taxes.”
Your profit is determined by what you paid + what you paid to repair subtracted from the price that you sold it.
Example: Your total investment dollar (purchase and rehab) is $75K. You sell for $100K. In between those two events, you did a cashout refi for $100K. Did you make a profit?
Answer is: YES. You made $25K in profit that you will have to pay taxes on. Profit-wise, the borrowed funds mean nothing (other than you won’t have a dime to pay the taxes with if you already spent it). The only help that a cashout refi gives on taxes is that in most cases, the interest is deductible, points and loan fees are usually deductible, but since those are actual costs, that doesn’t really help, does it?
Raj
This does not make sense. I thought that you pay taxes on the funds that you get at the closing, not on the purchase-sell price. It was reconfirmed by several other at this site that the money used to pay off the loans is not taxed.
Please explain… This may ruined my future plans of buying an island of Hawaiian islands 
It’s correct. You pay taxes on your gains. That’s why it’s called capital gains tax. The money you get at closing could be used to pay your taxes, but you’re not automatically taxed on whatever you get at closing.
The reason the money used to pay off the loan isn’t taxed is because the loan is part of your original basis. IE, you buy a property for 200k and have a 100k loan. If you sell it for 250k, you’ll need to apply 100k of that to pay off the loan. Now you’re going to be taxed on your 50k gain. Doesn’t matter if you have a loan or not.
How about this scenario:
You buy for $200K
You refinance 3 years later for $300K (used $100K for whatever purpose, perhaps vacation or reinvested)
You sell for $350K
Do you pay taxes on $50K (350-300) or $150 (350-200)?
You would pay taxes on the 150k gain you had. Of course if you spent 50k on the property, say new roof, kitchens, bathrooms, etc., that would mean your gain is really 100k, so keep track of all your receipts.
Also if you’re an investor, you can take that 150k gain and use it to purchase another property within 60 days, it’s called a 1031 exchange and you don’t pay any taxes on your gain. Of course there’s a lot of book keeping as you’ll get taxed when you finally cash out. The plan for many people is to never cash out if you don’t want to pay taxes…
If this property has been your residence, you’re entitled to an exemption from capital gains taxes on the first $250,000 of your profit when sell. (as long as you’ve owned the home and lived in it for at least 2 years). So, in the case you describe, you won’t owe any capital gains tax on the sale. Also, you don’t have to by a replacement property to take advantage of the exemption. If this has been a rental property, then it would be subject to the capital gains tax when it it sold. In that case you could avoid the tax by using a 1031 exchange to buy another property of at least equal or greater value. As long as the house is your primary residence- you have lived there in 2 of the last 5 years- your gain up to $250k/$500k for single/married is tax free. Any gain in excess of that is taxable. If you sell before the 2 years yes. Refi … no