Can I deduct the interest on a cash-out refinance of my rental?

How is interest on cash-out proceeds allocated?

Treasury Regulation 1.163-8T allocates debt by tracing disbursements of the debt proceeds to specific expenditures, and the allocation is not affected by which property secures the debt.

• Section 1.163-8T(b) defines the expenditure categories: trade or business, passive activity, investment, portfolio, personal, and former passive activity expenditures.
• Section 1.163-8T(c)(1) states that the allocation is not affected by the use of an interest in any property to secure repayment of the debt.
• If cash-out proceeds are spent on a rental, then the debt traced to those dollars is allocated to that rental expenditure.
• If cash-out proceeds are spent on a personal purchase, then the debt traced to those dollars is allocated to a personal expenditure.

Exception: Section 1.163-8T is a temporary regulation, and other rules, including the passive activity rules, can limit the deduction even after interest is allocated. A CPA applies the full set.

According to 26 CFR 1.163-8T, Allocation of interest expense among expenditures, electronic Code of Federal Regulations, as of October 2026.

Picture every dollar from the closing wearing a tag that says where it went. The rental secures the whole loan, but that doesn't make every dollar rental money. The tag follows the spending, which is why a refinance on a rental can still produce personal interest.

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What does IRS Publication 527 say about refinancing a rental?

IRS Publication 527 (2025) states that when you refinance a rental property for more than the previous outstanding balance, the portion of the interest allocable to loan proceeds not related to rental use generally can't be deducted as a rental expense.

• Publication 527 states that you can deduct mortgage interest you pay on your rental property.
• Publication 527 treats points as prepaid interest that generally can't be deducted in full in the year paid.
• Publication 527's example refinances a $100,000 balance into a $120,000 loan and uses the extra $20,000 to buy a car; the points allocable to the $20,000 are treated as nondeductible personal interest.

Exception: Publication 527 (2025) is guidance for 2025 returns. Check the edition for the year you are filing.

According to Publication 527 (2025), Residential Rental Property, Internal Revenue Service, as of October 2026.

The IRS example uses a car, but the pattern is the same for a kitchen in your own house or a tuition bill. If $20,000 of a $120,000 loan went somewhere personal, expect the interest on that $20,000 to be treated as personal, and size the deal knowing it won't show up as a rental expense.

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Does it matter where I deposit the cash-out money?

Yes. Under 1.163-8T(c)(4)(ii), debt proceeds deposited in an account are treated as spent before unborrowed funds already in the account and before amounts deposited later.

• Under 1.163-8T(c)(4)(ii), debt proceeds deposited in an account are treated as expended before unborrowed amounts already in the account and amounts deposited afterward.
• Under 1.163-8T(c)(4)(iii)(B), an expenditure from the account within 15 days after the deposit may be treated as made from the debt proceeds, up to the amount deposited.
• Under 1.163-8T(d)(1), when part of a debt allocated to several expenditures is repaid, the repayment is treated as coming first from personal expenditures, then investment and passive activity expenditures, then rental real estate passive activity expenditures with active participation, then former passive activity expenditures, and last from trade or business expenditures.

Exception: The account and ordering rules carry more detail than this summary. Treat this as background for a conversation with your CPA, not as a recordkeeping plan.

According to 26 CFR 1.163-8T(c) and (d), electronic Code of Federal Regulations, as of October 2026.

The cleanest file is a boring one: the proceeds land in an account that holds nothing else, and every check out of it has an obvious purpose. Mixing the money into your household account and sorting it out at tax time is how a simple refinance turns into an expensive afternoon with your CPA.

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Will a DSCR lender ask how I plan to use the cash?

It may. The borrower's statement of purpose is among the factors Regulation Z commentary 3(a)-3 lists for deciding whether credit is business or consumer credit, so a lender can ask how cash-out proceeds will be used.

• Comment 3(a)-3 to Regulation Z lists five factors for judging whether credit to finance an acquisition is business or consumer credit, including the size of the transaction and the borrower's statement of purpose for the loan.
• Comment 3(a)-4 deems credit to acquire, improve or maintain a non-owner-occupied rental to be for business purposes.
• If cash-out proceeds go to a purpose outside acquiring, improving or maintaining rentals, then comment 3(a)-4 does not describe that use, and the lender may weigh the 3(a)-3 factors.

Exception: How each lender documents purpose differs, so ask what yours requires.

According to Official Interpretations 3(a)-3 and 3(a)-4 to 12 CFR 1026.3, Consumer Financial Protection Bureau, as of October 2026.

Answer that question the same way on the loan file and on your tax return. If the money is going into the next rental, say so, keep the paper trail, and both the lender and your CPA have an easier job.

If the cash-out is coming off a recent flip, the seasoning rules for refinancing a flip decide when it's available.

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