I followed everything you stated until the last sentence "Your mortgage on home was 150K and because all of 350K out of 500K was used for rental home, you have 0 home equity indebtedness, you have assigned that loan to the rental. " If you do a refi for $500k and there is $150k left on your home mortgage and you use $350k for rental home, you should still be able allocate $150k for your home mortgage and $350k for your rental home. From a deduction perspective, you will need to allocate all the interest to your rental home until $350k of the principle has been paid off. Only then can you start deducting the interest from the $150k for your home. You still have $150k home equity indebtiness but you cannot deduct the interest until you have paid the $350k allocated to your rental home.
