Background

Refinancing a rental property loan is a common cash‑management move for investors. Owners refinance to lower rates and monthly payments, shorten or extend terms, or pull cash out for repairs or new investments. Timing matters: rate drops, rising values, or a need for capital often trigger refinancing decisions, but tax rules and loan costs determine whether the move really helps your after‑tax cash flow.

Key tax effects

  • Mortgage interest remains deductible as a rental expense when the loan is used for the rental activity. (See IRS Publication 527 for rental rules.)IRS Publication 527
  • If a refinanced loan is used partly for personal purposes (for example, you refinance a buy‑to‑let and take cash for a personal purchase), you must allocate interest between rental (deductible) and personal (possibly not deductible as a rental expense). Document use of proceeds carefully.
  • Points and many loan fees related to an investment mortgage are not deductible in a single year. They generally must be amortized over the life of the new loan; treat origination fees and points as loan costs for amortization rules. See IRS guidance on amortization and business expenses (Publication 535) and loan cost treatment.
  • Refinancing does not restart the property’s depreciation clock. Depreciation continues based on the original placed‑in‑service date and remaining basis. However, if you use cash‑out proceeds to make capital improvements, that spending increases basis and is depreciated prospectively (usually over 27.5 years for residential rental property per IRS Publication 946).
  • A cash‑out refinance is not taxable when you receive the proceeds, but how you use those proceeds affects tax outcomes (personal vs. capital improvement vs. business investment).

Cash‑flow considerations

  • Monthly payment change — Lower rate or longer term usually reduces monthly payments; shorter term usually raises them. Recasting amortization can change interest vs. principal mix and affect current taxable interest expense.
  • Closing costs — Lender fees, appraisal, title, and recording costs increase the upfront cost of refinancing. Include them when calculating your break‑even horizon.
  • Break‑even analysis — Divide total closing costs by monthly savings to estimate months to recoup costs. Also consider the loan’s new term: extending term may produce immediate cash‑flow relief but increase lifetime interest paid.

Example (illustrative)

Assumptions: original 30‑year loan on a $300,000 purchase with 6.00% rate; refinancing to 3.50% on a new 30‑year loan. Approximate monthly principal & interest payments:

  • Original: $1,798/mo (P&I) at 6.00%
  • Refinanced: $1,347/mo (P&I) at 3.50%

Monthly savings ≈ $451. If closing costs are $4,000, break‑even ≈ 9 months. (This is illustrative; use exact amortization schedules when deciding.)

Tax & accounting examples

  • Points/Origination fees: If you pay $3,000 in points on a new investment loan with a 10‑year term, you generally amortize those costs over the 10 years as an expense, reducing taxable rental income each year by the amortized amount.
  • Cash‑out to make roof repairs: $20,000 taken from refinance used to replace the roof increases the property’s basis by $20,000; you capitalize that expense and depreciate it over the asset’s recovery period.

Eligibility and practical triggers

  • Lenders typically review property income, borrower credit, debt coverage ratio, and loan‑to‑value (LTV) for rental properties. Borrowers with higher credit scores and stronger debt coverage ratios get better offers.
  • Consider refinancing when rate differentials are meaningful after costs, when you need capital for value‑creating repairs, or when changing loan structure (fixed vs adjustable) reduces risk.

Professional tips and strategies

  1. Calculate the true break‑even date: include appraisal, title, escrow, and any prepayment penalties. Our related article on origination points shows how fees affect break‑even timing.
  1. Allocate interest if proceeds are mixed-use. Keep a clear paper trail (loan statements, bank transfers, contractor invoices) to support deductions in case of audit.
  2. Use cash‑out proceeds strategically: fund capital improvements (which increase basis and are depreciable) or fund another investment that produces taxable income to absorb losses if you’re in a passive activity position.
  3. Shop lenders for both rate and fees. Neglecting fees can turn an apparent rate win into a money‑losing decision.
  4. Consult a tax professional before finalizing a refinance. Complex allocations, partnerships, and cost capitalization rules often require tailored guidance.

Common mistakes to avoid

  • Forgetting to allocate interest when the refinance proceeds are used partly for personal purposes.
  • Assuming refinancing restarts depreciation or creates immediate deductible losses—depreciation and basis rules still apply.
  • Ignoring closing costs in break‑even calculations.
  • Failing to document how refinanced funds were used.

Quick FAQ

  • Will refinancing change my rental depreciation? No — depreciation continues based on the original placed‑in‑service date; only capital improvements funded by refinance add to basis and generate new depreciation.
  • Is a cash‑out refinance taxable? No, loan proceeds are not income, but their use affects deduction and capital treatment.

Authoritative sources

Internal resources

Professional disclaimer

This article is educational and not personalized tax or legal advice. Rules change and facts depend on your situation; consult a certified tax professional or CPA before acting.