I've read through pub 936 and can't find anything that would make it a SCH E deduction beyond the tax year of the payoff. I do agree that it's not a SCH A deduction since it's not acquisition debt though. (the pub clarified that quite well) Seems to be treated the same as a HELOC where the money was not used to maintain or improve the property that secured it. (or any other property for that matter.)
Now it does "appear" that any amount of the final payoff amount that was interest would be a SCH E deduction. So for example, if the payoff amount on the rental was $100,000 and say, $7000 of that payoff was the final interest payment on that loan, then that interest, and only that interest amount would be a SCH E deduction. After that, no more interest can be deducted on the primary residence loan anywhere on the tax return.
Had the money been used to acquire, maintain value in, or improve the rental property, then it could be a SCH E deduction. But the money wasn't used for any of that. It was used to "pay off" the rental mortgage.
Seems it would have been better to refi the rental and pay off the primary residence. Then you would have at least part of the interest deductible on SCH E if it was a "true" refi with cash out.
I have a neighbor a few houses down from me that's a CPA and runs his own H&RB franchise. He's out of town until the weekend. Hopefully I will remember and present this to him after he gets home and has time to settle back into things around here. But based on what I know now and my interpretation of 936, the interest on the loan isn't deductible on SCH E or SCH A.
I'm going through 936 again. This time I'm checking anything that pub references that might be related to this specific situation.
