For tax year 2018 (and onward), will the interest on Home Equility Line of Credit (HELOC) taken in calendar year 2018 on a primary home (owner living in full time) be deductible if that loan is then used to by a new home and this new home then becomes the primary home (and the old home, on which the HELOC was drawn, is still owned but rented out)?
Yes, but just in case make sure you can prove the HELOC money was used to purchase a new home with - every penny of it.
I take it after moving into the new home, you will be converting the old home to residential rental real estate. If so, then make sure you keep meticulously detailed records for your rental expenses and income along with the dates major events occur. You will also need your HUD-1 closing statement from when you originally purchased that home too, along with your closing statement from the refi. So keep every single scrap of paperwork you are provided at the closing.
Then during your physical move to the new house, make absolutely certain that you retain every scrap of paper from your purchase of the old house, along with the HELOC paperwork. If you don't do this, I can practically guarantee you'll find yourself in IRS Tax Hell with no way out.
Then if necessary and when ready to report your rental income/expenses on your tax return let me know. I've got a TON of information that not only will be helpful and informative to you, but may also save you grief with the IRS in the future too.
It is absolutely imperative when converting a property from personal use to a rental, that you get your numbers spot on perfect in that first year. The tiniest mistake has the huge potential of getting exponentially larger as the years pass. Then when you catch your error the cost of fixing it to make things right can be quite costly. So for that first year perfection is not an option... it's a requirement.
What follows are things the program will ask you for that are better clarified below than they are in the program. So when going through the process if there is doubt...***ASK!!!!***. The only stupid questions are the ones you don't ask. So don't be timid about it. So what if others think it's stupid? It's not their money! It's yours!
So print the below and file it with your collection of paperwork that you are keeping for your 2018 tax return.
Date of Conversion - If this was your primary residence before, then this date is the day AFTER you moved out. In Service Date - This is the date a renter "could" have moved in. Usually, this date is the day you put the FOR RENT sign in the front yard. Number of days Rented - the day count for this starts from the first day a renter "could" have moved in. That should be your "in service" date if you were asked for that. Vacant periods between renters count also PROVIDED you did not live in the house for one single day during said period of vacancy. Days of Personal Use - This number will be a big fat ZERO. Read the screen. It's asking for the number of days you lived in the property AFTER you converted it to a rental. I seriously doubt (though it is possible) that you lived in the house (or space, if renting a part of your home) as your primary residence or 2nd home, after you converted it to a rental. Business Use Percentage. 100%. I'll put that in words so there's no doubt I didn't make a typo here. One Hundred Percent. After you converted this property or space to rental use, it was one hundred percent business use. What you used it for prior to the date of conversion doesn't count.
Property improvements are expenses you incur that add value to the property. Expenses for this are entered in the Assets/Depreciation section and depreciated over time. Property improvements can be done at any time after your initial purchase of the property. It does not matter if it was your residence or a rental at the time of the improvement. It still adds value to the property.
To be classified as a property improvement, two criteria must be met:
1) The improvement must become "a material part of" the property. For example, remodeling the bathroom, new cabinets or appliances in the kitchen. New carpet. Replacing that old Central Air unit.
2) The improvement must add "real" value to the property. In other words, when the property is appraised by a qualified, certified, licensed property appraiser, he will appraise it at a higher value, than he would have without the improvements.
Cleaning & Maintenance
Those expenses incurred to maintain the rental property and it's assets in the useable condition the property and/or asset was designed and intended for. Routine cleaning and maintenance expenses are only deductible if they are incurred while the property is classified as a rental. Cleaning and maintenance expenses incurred in the process of preparing the property for rent are not deductible.
Those expenses incurred to return the property or it's assets to the same useable condition they were in, prior to the event that caused the property or asset to be unusable. Repair expenses incurred are only deductible if incurred while the property is classified as a rental. Repair costs incurred in the process of preparing the property for rent are not deductible.
Additional clarifications: Painting a room does not qualify as a property improvement. While the paint does become “a material part of” the property, from the perspective of a property appraiser, it doesn’t add “real value” to the property.
However, when you do something like convert the garage into a 3rd bedroom for example, making a 2 bedroom house into a 3 bedroom house adds “real value”. Of course, when you convert the garage to a bedroom, you’re going to paint it. But you will include the cost of painting as a part of the property improvement – not an expense separate from it.
Please be careful with this one. Some of the rules are still evolving. But as of now, the only thing that I can find is IR-2018-32, Feb. 21, 2018 along with additional analyses in some magazines, such as Forbes. The IRS IR-2018-32 appears to indicate that the interest on a HELOC is intended to be deductible only when used to improve the property on which the loan is secured. Specifically, the release gives the following example, "In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $250,000 loan to purchase a vacation [I read that as a second residence] home. The loan is secured by the vacation home. Because the total amount of both mortgages does not exceed $750,000, all of the interest paid on both mortgages is deductible. [But note this last part in particular.] However, if the taxpayer took out a $250,000 home equity loan on the main home to purchase the vacation home, then the interest on the home equity loan would not be deductible." I have not been successful in finding additional information. Since the money from the mortgage is not used for the home that has the mortgage, then I am not comfortable telling anyone that it will be deductible. To me, it appears to be not deductible. If there are additional rulings, I request to know the specific references.
The IRS Pubs on this do not as of yet provide the clarity needed on this. As it stands now things can be interpreted either way for this particular thread, and neither interpretation can be proven as correct, or wrong.
I'm sure folks have their reasons. But taking out a HELOC on an existing property to purchase another property doesn't make sense to me. It would make more sense to let the new property secure it's own mortgage.
Interest rates aside, if you have a HELOC and for whatever reason can't make your payments on the primary and HELOC, that puts all at risk. Contrary to what folks may think, the 2nd home purchased with the HELOC is at risk too when it comes to getting behind on payments.