It is clear that if I use entire HELOC portion for buying a new rental I can claim the interest on that 300K against rental income from that property. Is that the case even if I use entire 300K of HELOC to pay off the mortgage that I already have on rental property? My understanding is that this strategy works.
If my interest rate is 10% and home acquisition debt is 300K, my mortgage interest is 30K for that year. Did I get that right? Yes. If mortgage interest is 30K, then whatever interest I have on 1098 - (minus) 30K is interest on HELOC. Yes
and just so terms are in synch. You borrowed $600,000. the IRS doesn't care whether that is called a HELOC or Cash out refi, Heloan or whatever term your bank used. What the IRS cares about is how much 'acquisition' debt was outstanding on your personal home at the time of this mortgage transaction. Whatever that balance was (assuming you had not cashed out before which makes this conversation trickier) is the 'acquisition debt' and the interest on that balance is tax deductible on Schedule A. The rest IS NOT deductible on Schedule A. For it to be deductible you'd have to invest it in a rental property or business where it could be deducted on the appropriate schedule. If you took the money and used it to purchase (or pay off a mortgage) on a vacation / 2nd home, it would not be deductible since it would have to go on Schedule A and 'the rest is not deductible on Schedule A"
