What mortgage balance should I use when I calculate the average for the mortgage of the rental home.
Hiere's my take on it. Hopefully someone else can cite some ruling and prove me wrong.
You still have to use the original mortgage balance. That's because it was in fact, 100% personal use before you converted it to a rental, and the interest paid before it was a rental was on 100% of the outstanding mortgage balance. Before you converted it to a rental, all of that outstanding mortgage balance was subject to the $750K limitation. After you converted to a rental, none of the outstanding balance was subject to any limits.
Example: (I'm using extremely inaccurate and rough numbers here for simplicity)
On Jan 1 2023 you have a $1,000,000 outstanding mortgage balance. Your interest rate is 10% or $8,333 in interest per month.
On July 1st you converted the property to a rental and placed it in service.
For the first six months (Jan-Jun) you paid $8,333 each month in interest for a total of $10,000 in interest.
You can only claim interest paid on 75% of the balance, or $750,000. Therefore, 75% of your $10K in interest is $7,500 and that's the limit of your interest deduction on the SCH A for the first 6 months of the year.
For the 2nd six months (Jul-Dec) you paid $10,000 in interest and it's all deductible on SCH E for the period of time it was a rental, which is basically business use property. So there is no limitations there.
Again, the above is using extremely rough (but somewhat close) numbers with some very simplified (and inaccurate) math. As you know, with each monthly payment the amount of that payment applied to the principle increases while the amount applied to the interest payment decreases.
