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Consider the following scenario:

  • an existing mortgage on a property worth 300k, with a current mortgage balance of 100k.
  • a cash-out refinance for 200k, releasing 100k of funds.

If we use that 100k to purchase an empty lot, how is the interest on this debt taxed? (USA jurisdiction) I can come up with a few pieces of the puzzle:

  • it's definitely NOT mortgage acquisition debt, since it wasn't used to build or improve the main home.
  • if we buy that lot, and then choose NOT to build on it, does it count as an investment property? Presumably (or at least hopefully) the value will increase and as such that interest is deductible as an investment expense.
  • if we end up building on that lot, does the interest become home acquisition debt (and thus taxable?)

Given that there's no way to tell at present whether the lot will become a home, or become an investment that gained/lost value, what happens in the interim before some decision gets made?

  • I'm not sure which jurisdiction you're asking about, but in Australia (and many other countries, I'd imagine), borrowings aren't normally taxed unless you're doing some funny business with the accounting. They might even count as a deduction. Taxes are normally levied on your earnings. – Lawrence Sep 23 at 15:35
  • Cash out refinance isn't taxed because you don't have any income. Your net worth actually decreases due to closing costs and related expenses. – xyious Sep 24 at 16:03
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Amending my original answer in response to the comment from mhoran_psprep.

The interest on the $100k you receive back would only be deductible if you were to use the money to improve upon the home used to secure the debt. Purchasing a new property would not qualify, since the loan would only be secured by the original property that you refinanced.

So, for your scenario, the interest on the $100k used to pay off the original mortgage would be tax deductible, assuming this is your primary home or a vacation home. The interest on the $100k cash-out would not be deductible if used to purchase an additional property.

This article summarizes the recent changes to US tax law applicable to this scenario: https://www.taxslayer.com/blog/can-i-deduct-the-mortgage-interest-deduction/

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    Unfortunately the tax law changes that started in 2018 make the interest only partially deductible. The interest on the 100K cash out isn't deductible because it isn't used to improve the house. – mhoran_psprep Sep 24 at 10:43
  • Do you have a source for that ? This is the first time I hear that. – xyious Sep 24 at 16:03

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