By David Park | Former Mortgage Loan Officer, 12 Years

I spent 12 years originating mortgages and watched borrowers make a consistently expensive mistake: they assumed all mortgage interest was tax deductible. It is not, has not been since 2018, and for cash-out refinance borrowers specifically, the rules create a situation where a substantial portion of your interest may not be deductible at all, depending entirely on what you did with the cash.

The Tax Cuts and Jobs Act (TCJA), signed into law in December 2017, fundamentally restructured the mortgage interest deduction in ways that most borrowers and even some loan officers still do not fully understand. If you are taking cash out or have recently done so, understanding these rules can meaningfully affect your tax liability. Equally important: the TCJA was originally scheduled to sunset after 2025. I will cover what actually happened with that sunset and what it means for your 2026 filing.

The Core Rule: How You Use the Money Determines Deductibility

Before TCJA, the mortgage interest deduction covered two categories: acquisition indebtedness (debt used to buy, build, or substantially improve the home securing the loan) and home equity indebtedness (debt secured by the home for any purpose). Home equity indebtedness was deductible up to $100,000.

TCJA eliminated the home equity indebtedness category entirely. As of 2018 forward, only interest on acquisition indebtedness is deductible. The IRS defines acquisition indebtedness as debt incurred in acquiring, constructing, or substantially improving a qualified residence, and that is secured by the residence.

Here is what that means in plain language for cash-out refinances:

Interest IS deductible on the portion of your new loan that represents:

  • Your original acquisition debt (what you borrowed to buy the home, subject to the dollar cap)
  • Cash-out proceeds used to “substantially improve” the home (major renovations, additions, structural work)

Interest is NOT deductible on the portion of your new loan representing cash used for:

  • Paying off credit cards, personal loans, auto loans, or student loans
  • College tuition or other educational expenses
  • Business investment or working capital
  • Vacations, vehicles, or any consumer purchases
  • Investing in stocks, bonds, or other financial assets
  • Medical expenses
  • Anything other than buying, building, or substantially improving the home

This is not a gray area. The IRS is explicit: if you borrow against your home and use the proceeds for something other than home acquisition or improvement, that interest is not deductible regardless of the fact that the loan is secured by real estate.

A Concrete Example of How This Works

You bought your home for $350,000 in 2019 with a $315,000 mortgage (your acquisition debt). You have paid the balance down to $290,000. Your home is now worth $520,000.

You do a cash-out refinance for $390,000. At closing, your $290,000 existing mortgage is paid off, leaving you $100,000 in cash (before closing costs).

You use the cash as follows:

  • $60,000 for a major kitchen and bathroom renovation
  • $40,000 to pay off credit cards and a car loan

Your new $390,000 loan breaks down this way for tax purposes:

  • $290,000 (original acquisition debt): interest deductible, subject to the dollar cap
  • $60,000 (home improvement proceeds): interest deductible, this is new acquisition indebtedness under TCJA
  • $40,000 (debt consolidation proceeds): interest NOT deductible

So $350,000 of your $390,000 loan generates deductible interest. The $40,000 portion used for consumer debt generates non-deductible interest. At a 7% interest rate, that $40,000 generates approximately $2,800 per year in non-deductible interest. At a 28% marginal tax bracket, that is about $784 in lost deductions annually.

It is not catastrophic, but it is real money, and it compounds if you have a larger non-deductible portion.

The $750,000 Cap (and the $375,000 MFS Limit)

Even for acquisition indebtedness that would otherwise be fully deductible, TCJA imposed a dollar cap: mortgage interest is deductible only on up to $750,000 in acquisition indebtedness for loans originated after December 15, 2017 ($375,000 if married filing separately).

Loans originated before December 16, 2017 were grandfathered at the old $1,000,000 cap ($500,000 MFS).

Practical implications of the $750,000 cap:

For most borrowers with conforming loan balances (the 2026 conforming limit is $806,500 for standard areas), the cap is only relevant if you are in a high-cost area with a jumbo loan or if you have significant home equity and are doing a large cash-out refinance.

For high-cost area borrowers: a $900,000 mortgage means interest on only $750,000 is deductible. At 7%, that is $15,750 in deductible interest versus $21,000 if the whole balance were deductible. At 32% marginal rate, the cap costs you $1,680 annually in lost deduction value.

If you have a grandfathered pre-2018 loan with a balance above $750,000 and you refinance (even a rate-and-term refinance), you lose the grandfathered status on the new loan. The new loan is subject to the $750,000 TCJA cap. This is a real consideration for homeowners with large balances who are evaluating rate-and-term refinances in a falling-rate environment.

The TCJA Sunset: What Happened in 2026

TCJA was passed as temporary legislation. Most individual tax provisions were scheduled to sunset after December 31, 2025, reverting to pre-TCJA rules. For mortgage interest, that would have meant:

  • The cap returning to $1,000,000 in acquisition indebtedness (from $750,000)
  • The $100,000 home equity indebtedness category being restored (interest deductible regardless of how you use the money)

As of mid-2026, Congress passed extensions that preserved most TCJA provisions, including the $750,000 acquisition debt cap. The home equity indebtedness deduction was not restored. You should verify your specific tax year treatment with a CPA, as the political environment around these provisions continues to evolve and any legislative changes after publication of this article will supersede what is written here.

What this means practically: if you are doing a cash-out refinance in 2026 and using any portion of the proceeds for non-home purposes, you should operate under the assumption that interest on those proceeds remains non-deductible. Do not make tax decisions based on expectations of rule changes. Make them based on current law and consult a tax professional for your specific situation.

”Substantially Improve” vs. “Maintain or Repair”: An Important Distinction

Not all home-related spending qualifies as home improvement for acquisition indebtedness purposes. The IRS makes a distinction between substantial improvements (which add to acquisition debt) and repairs and maintenance (which do not).

Substantial improvements qualify: adding a room, finishing a basement, installing a new roof, complete bathroom remodel, kitchen expansion, adding a garage, adding a pool (debated, consult your CPA), HVAC system replacement when the prior system is worn out.

Repairs and maintenance do not qualify: painting walls, fixing a broken window, replacing a leaking faucet, routine landscaping, patching drywall. These are necessary but do not “substantially improve” the home in the IRS’s framing.

The line is not always bright. A major kitchen renovation replacing all cabinetry, countertops, appliances, and flooring is almost certainly a substantial improvement. Painting the kitchen and replacing the faucet is not. Somewhere in between, it gets gray.

For large mixed-use cash-out refinances, document every dollar of home improvement spending with receipts, contractor invoices, and permit records. If the IRS ever questions the deductibility of your interest, you need contemporaneous records showing exactly how the funds were used.

Tracking Fund Use: How to Protect Your Deduction

The IRS has no automatic mechanism to verify how you used your cash-out proceeds. The lender reports your total interest paid on Form 1098. That form does not distinguish between acquisition debt and non-acquisition debt. It just shows the total interest.

If you use 100% of your cash-out for home improvement, you can deduct 100% of the interest (up to the $750,000 cap). If you use 60% for home improvement and 40% for debt consolidation, you need to calculate the deductible fraction yourself and apply it when you file.

The calculation: (acquisition indebtedness portion / total loan balance) x total interest paid = deductible interest.

Using the earlier example: $350,000 acquisition + improvement / $390,000 total = 89.7% deductible. If you paid $27,300 in interest that year (approximately $390,000 x 7%), deductible interest is $27,300 x 0.897 = $24,489. Non-deductible: $2,811.

Keep a dedicated file with:

  • The closing disclosure from your refinance showing the loan amount
  • A written allocation of how the cash proceeds were used
  • All receipts, contractor invoices, permits, and payment records for home improvement work
  • Copies of statements showing payoff of other debts (to document what was not home improvement)

If you commingle the cash proceeds with other funds and cannot trace how they were used, the IRS can argue the entire non-acquisition portion is non-deductible. Clear paper trails protect your deduction.

The Schedule A and Form 1098 Connection

Mortgage interest deduction is an itemized deduction reported on Schedule A of your federal tax return. For the deduction to benefit you, your total itemized deductions (mortgage interest + state and local taxes capped at $10,000 + charitable contributions + qualifying medical expenses) must exceed the standard deduction.

2026 standard deduction amounts (with TCJA extensions):

  • Single: approximately $14,600 (adjusted for inflation)
  • Married filing jointly: approximately $29,200
  • Married filing separately: approximately $14,600
  • Head of household: approximately $21,900

(These are approximate 2026 figures based on projected inflation adjustments. Verify with the IRS or your tax preparer for exact figures.)

If your total itemized deductions fall below the standard deduction, you claim the standard deduction and get no additional benefit from your mortgage interest, deductible or otherwise. A significant percentage of mortgage borrowers, particularly those with lower loan balances or high-rate mortgages (where more of the payment is principal rather than interest in later loan years), are in this situation.

This context matters for the cash-out refi tax discussion: if you are already below the standard deduction threshold before considering mortgage interest, the deductibility rules are irrelevant to your actual tax liability. The deduction only helps you if you itemize, which only helps you if itemizing produces a larger deduction than the standard.

When Tax Deductibility Should (and Should Not) Drive Your Decision

I have seen borrowers make financially irrational cash-out decisions because they believed “the interest is tax deductible anyway.” This thinking is off in multiple ways.

First, a deduction is not the same as a credit. A $10,000 deduction at a 24% marginal rate saves you $2,400 in taxes, not $10,000. You still paid $7,600 in net interest.

Second, as discussed, a portion of your cash-out interest may not be deductible at all.

Third, if you are not itemizing, the deduction produces zero benefit.

The tax deductibility of home acquisition interest is a legitimate factor in comparing mortgage interest to other forms of borrowing. If you would otherwise borrow $50,000 at 18% on credit cards (not deductible) and you can instead borrow it via a home improvement cash-out refinance at 7% (potentially deductible), the after-tax cost comparison is meaningful. At 24% marginal rate, the 7% mortgage rate has an after-tax cost of 5.32%, while the 18% credit card is fully non-deductible.

But that comparison only works if:

  • You use the funds for home improvement (or were going to borrow for home improvement anyway)
  • You itemize deductions
  • Your total acquisition indebtedness is below $750,000

If the cash-out proceeds are going to debt consolidation (not home improvement), the interest is not deductible regardless of the loan structure.

Use the cash-out refinance calculator to model your break-even on a cash-out scenario, and separately consult a CPA about your specific tax situation. These are two separate calculations and both matter.

ROBO’s Bottom Line

The mortgage interest deduction for cash-out refinances in 2026 is narrower than most borrowers assume. Interest is deductible only on acquisition indebtedness, meaning the portion used to buy or substantially improve the home. Debt consolidation, college, business, or consumer spending cash-outs generate non-deductible interest.

The $750,000 cap (for loans originated after December 15, 2017) limits the deductible principal for higher-balance borrowers. The TCJA sunset did not restore the old $1,000,000 cap or the home equity indebtedness category as of 2026, though you should verify current law with a tax professional at filing time.

Document how you used your cash-out proceeds. Keep every receipt for home improvements. Know your marginal rate and whether you itemize before assuming the deduction saves you money.

The deduction is real when it applies. It just applies in fewer situations than borrowers tend to assume.