First point. Mortgage interest is deductible on schedule A for your main home and one second home, up to a combined limit of $750,000. In order to be deductible, the mortgage cannot exceed the acquisition cost of the home. For example, suppose you bought the home for $100,000 and your mortgage balance is currently $50,000. The home is worth $300,000, allowing you to take out a $200,000 home equity line of credit. Only $50,000 of the equity loan would be deductible interest, because that is the limit of your acquisition cost. So, depending on your other circumstances, you might be able to take out a mortgage on your main home, use it to purchase a rental property, and deduct some of the interest on schedule A, but maybe not all of it.
Second point. You can deduct the interest on schedule E, for a loan that you use to buy the rental property, regardless of where the loan came from or how it was secured, even if it was secured as a mortgage on your main home. There is no upper limit on the schedule E mortgage deduction like there is on a personal home mortgage. Deducting the interest on schedule E lowers your taxable rental profit, which is generally a good idea.
However, there are two additional points that you need to be aware of.
Third point. You must be able to follow the tracing rules with your deductible interest. For example, if you use the home mortgage to entirely buy a rental property, and nothing else, then you can trace the interest to the rental property. However, if you use some of the mortgage to pay off bills or take a vacation, then it becomes more difficult to trace the interest from the mortgage to the rental property. And the more complicated you make your finances and the more things you use the money for, the harder it is to trace the expense. If you can’t prove the interest is traceable, you would lose the deduction in an audit.
Fourth point. In order to treat the loan as a business loan to deduct rental interest in schedule E, you have to make an election (choice) to treat the loan as if it was not secured by your home. That means you can never deduct the interest as a personal mortgage on Schedule A, even if your circumstances change and it would be better to do so.
