Generally, a mortgage refinance does not influence property taxes one way or another, but this isn’t the case for certain types of cash-out refinance loans. When a borrower uses the money from a cash-out refinance to improve a home, increased property tax liability can result. There are certain rules you need to follow if you want to remodel your home while avoiding property tax.
Being able to refinance and use built-up equity to either spend or invest more is one of the most advantageous aspects of real estate. In fact, there is a whole investment method that revolves around building a property portfolio via refinancing called the BRRRR method. That being said, whether you are a serial real estate investor building a portfolio or just need to refinance to pay for a wedding, an increase in your property tax bill can increase your annual expenses and reduce your yield. Does this happen in the case of a refinance? Most of the time, no, but sometimes, yes. Does refinancing and an appraisal affect property taxes? Let’s explore this question.
Does a refinance increase property taxes?
No, generally speaking, a refinance does not affect property taxes. When a refinance occurs, the property is appraised by a private surveyor, not assessed by the county. However, if funds derived from a cash-out refinance are used to remodel or change the property significantly, this could trigger a county reassessment.
Property values are appraised differently
It’s important to understand the fundamental reason why refinancing will not affect property taxes. It’s based on whether the value of the property is being appraised or assessed.
You may get your home appraised for sale, for a refinance, or for other reasons. Often, you yourself will hire an independent property appraiser to appraise your home. If you are taking out a loan, then the bank or mortgage lender will appoint a property appraiser to value your home. As the work of an independent private business, this appraiser’s valuation does not affect how the government values your property. Private mortgage insurance and some closing costs, however, can be affected by this property appraisal.
Conducted by a government, such as a county or municipality, a property assessment ascertains the value of the property for tax purposes. Depending on the jurisdiction, a property assessment will work like clockwork with a couple of exceptions. If the property is bought and sold, and if the property changes structurally, that might incur an additional assessment via your local tax authority. Cash-out refinances for remodeling or home improvement purposes, thus, could be an issue. A simple home equity loan should not prompt an assessment, but a cash-out refinance can be an entirely different story.
Cash-out refinance for home improvement
As previously noted, a cash-out refinance alone does not trigger a property tax reassessment. If you use the money to improve, remodel, or reconstruct the property in any way, however, that could incur an assessment by your county or municipality and increase the property’s assessed value. This can be particularly tricky when trying to build a portfolio using a method like the BRRRR method.
Consider this model investment from our article on the BRRRR method:
|Description||Property 1||Property 2||Property 3|
|Money Put Into Rehab||$25,000.00||$10,000.00||$15,000.00|
|Closing and Lending Costs||$6,000.00||$5,625.00||$6,750.00|
|Value After Rehab||$500,000.00||$475,000.00||$600,000.00|
|Cash Out Refinance @ 80%||$400,000.00||$380,000.00||$480,000.00|
|Debt Owed on Original Mortgage||$280,000.00||$262,500.00||$315,000.00|
|Total Net After Cash Out Refinance||$120,000.00||$117,500.00||$165,000.00|
In this model, we have a specific portion of the money put into rehabbing or renovating the property. This structure relies on a constant stream of cash-out refinances to keep adding to the portfolio while creating value appreciation. It will also help to maintain a yield that will allow owners to “wash their faces” or have their rental income cover the mortgage. But if property tax increases, this will eat into the yield.
Remember, protect the yield at all costs
Your ability to take on debt and maintain a break-even or positive cash flow when renting a property out is key. The easiest way to do this is to put all of the data you are aware of into a rental income calculator or get specialized software like that provided by Spark Rental.
The more property you acquire, the more you should look at making essential tasks, like keeping track of mortgage interest, easier with technology.
Protecting your yield also means taking advantage of all the tax deductions that might be available to you, such as the mortgage interest deduction or depreciation. Furthermore, if you are running a business via property investment, then you can deduct certain business expenses that are tied to running and operating the property.
Cash-out refinance remodeling rules
If you absolutely have to spend your cash-out refinance money on improving an existing property, then there are some rules you should follow. There are certain things that can trigger a property tax reassessment and certain things that cannot.
Different real estate pros may give you different advice when it comes to remodels that will not incur a property tax reassessment. Repairing or replacing features that the property already has may be one of the safest options. Martin Orefice, a real estate professional and owner of Rent to Own Labs, explains why: if you want to avoid triggering a reassessment of your property for tax purposes, you should
Orefice further advises property owners that they
Keeping this sage advice in mind, let’s survey the types of remodels that will and won’t trigger reassessments once the assessor learns about them.
Remodels that will trigger a property tax reassessment
Remodels that you can expect to increase your property’s assessed value, and thus raise your taxes, include adding additional structures, making additions to the home, converting indoor spaces to more valuable uses, and finishing unfinished areas in the home.
Pools, tennis courts, barbecue pavilions, and anything that’s a separate structure adjoined to the property constitute additional structures and will likely trigger a property tax reassessment. For instance, if you transform a house with raw land in the backyard into a house with tennis courts and an outdoor bowling alley, you an expect a higher assessment and higher property taxes.
Adding to the home’s living space will add to the home’s value and thus trigger a reassessment of property tax. For instance, if you need to add a spare room, one trick could be to partition a larger room and operate it as a “Manhattan Studio.” There are some jurisdictions, however, where ADU (Additional Dwelling Units) will not trigger a reassessment of property tax, particularly if it’s for family members. It’s best to check with your local council or tax authority.
When conducting a property assessment, assessors will commonly look at indoor living space when determining the property’s value. If you convert a garage into an “in-law” unit, for example, this can increase the indoor living space and, thus, the property tax.
Finishing the unfinished
Unfinished basements or attics that can be living spaces will incur a higher property tax assessment if you finish them. Finishing unfinished spaces adds to the living area square footage, making your property more valuable. This can have negative tax consequences when the assessor comes around. On the positive side, these potential tax implications provide you with a handy excuse to tell your partner who wonders why you haven’t finished the basement in all these years.
Remodels where you won’t trigger a property tax reassessment
There are a few different things you can do to improve the property while not significantly increasing its value. Effectively, it’s normal things that you might do to improve your living standards, regardless of the value. These can include the following:
How to make a home better without (much) raising its taxable value
- Do some painting.
- Complete routine repairs.
- Install new flooring.
- Add new cabinetry.
- Make energy-efficient upgrades. Get new windows or appliances, for example.
- Upgrade your landscaping.
- Remove a wall or make certain similar structural changes.
Pro tip: if you’re preparing to resell, consider cleaning products
Does refinancing your house affect taxes?
In regard to property taxes, not necessarily. If you do a cash-out refinance and use the cash for home remodeling, this can increase the value — which, in turn, can lead to higher property taxes. A home equity loan or a home equity line of credit will not trigger changes in property taxes.
Do you have to report a refinance on you taxes?
No, the proceeds from a cash-out refinance are not taxable. This is because you are taking out debt, which is backed up by the equity in your property and is, thus, tax-deductible. If you were to sell the property and take a capital gain, then you would be liable for capital gains tax. Remember, debt is not taxed, but realized profit is.
Does refinancing affect capital gains tax?
No, capital gains tax is only triggered when you realize gains, such as when you sell a home that has increased in value.
Is an appraisal required for a refinance?
Yes, an appraisal is always required for a refinance. Refinancing depends on the value of the property, and in order for you to tap equity, you need to find out how much equity is available. Any time that a bank, mortgage lender, or general financial institution is involved in a deal, it will want an independent appraiser to determine what the value is.
Does refinancing hurt your credit?
Not unless you don’t pay your mortgage. If you missed property tax payments, this doesn’t affect your credit, either. This is due to a regulation passed in 2018, but the Consumer Financial Protection Bureau stipulates that credit agencies can no longer use unpaid taxes to affect credit scores.
- Generally, a mortgage refinance does not influence property taxes one way or another, but this isn’t the case for certain types of cash-out refinance loans.
- There is a difference between a private appraisal and a government assessment. One does not affect the other.
- You only need to worry about a refinance affecting property tax if you use the cash-out refinance to fund additional construction (such as a room addition) or home renovation.
- There are some remodels and renovations you can undertake with money from a cash-out refinance that won’t incur a property tax reassessment. Other remodels and renovates will result in a reassessment — once the assessor learns about them.
View Article Sources
- About Publication 527, Residential Rental Property (Including Rental of Vacation Homes) — Internal Revenue Service
- Credit Reports and Scores — Consumer Financial Protection Bureau
- Fair Credit Reporting Act, 15 U.S.C § 1681, Revised September 2018 — Federal Trade Commission
- Mortgage Interest Deduction — Tax Foundation
- How Long Does an Appraisal Take? Here’s What to Expect — SuperMoney
- How Long is an Appraisal Good For? — SuperMoney
- The BRRRR Method: Building Wealth Through Real Estate Investment — SuperMoney
- Shared Appreciation Mortgages: The Good, The Bad, and Tax Implications — SuperMoney
- What is a Tax Abatement and How Does It Work? — SuperMoney