I'd argue that he can't deduct the interest related to the entire $1mm loan against the primary residence, as "cash out" interest can only be deducted if the principle was reinvested to improve that primary residence
Actually, there is no argument on that, because you're right. He can only claim/deduct that portion of the interest that applies to whatever the outstanding balance on the original loan was, prior to the refi. The fact they used the "cash out" to pay off the rentals is completely irrelevant and just doesn't play into this since the rentals are not collateralize against the refi $1M loan at all.
So while interest percentage-wise it saves 1 lousy percent on the interest, it actually reduces the dollar amount of total interest paid overall. The downside is that the amount of "deductible" interest is significantly reduced, but so what? Depending on the rent being charged, the amount of rental income money he actually gets to keep instead of sending it to the mortgage company in the form of non-deductible principle will be as much as 40% more or less, depending on how far he was into the mortgages on the rentals prior to paying them off.
So while the tax liability overall may not change much, he gets to actually keep in his pocket more of the money that he would pay taxes on anyway, without the refi. So after that train of thought, I'd do the refi and just accept the fact that 30% (more or less) of my interest on the refi loan would not be deductible.
