Allocation of mortgage payments on loan used to purchase multiple properties

[Dave918]

I used some of the money from a refinance of the mortgage on rental property A to buy rental property B. So based on the tracing rules I need to allocate the mortgage interest between rental property A and rental property B. How should I allocate the principal payments as the mortgage is repaid (to rental property A which the loan is secured to or to rental property B)? I a section in 26 CFR Ch 1 titled "Supplemental ordering rules" which indicates that the order of repayment (when both debts are in the same class in this case rental real estate) is based on the order that the debts were allocated (which in this case would be rental property A since that debt was incurred first) - does this make sense?

https://www.govinfo.gov/content/pkg/CFR-2020-title26-vol3/pdf/CFR-2020-title26-vol3-sec1-163-8T.pdf

https://www.law.cornell.edu/cfr/text/26/1.163-8T

[JosephS1]

If the mortgage was secured from the equity in rental property A then yes the proper treatment would be to allocate it to property A.  As you are required to list the addresses of rental properties, and as the address that secures the mortgage is most likely listed in Box 8 of your 1098, this would be the least complicated way of taking the mortgage interest deduction.  

If you wish to allocate it property B, or to both of the properties, which is not unreasonable, since the mortgage proceeds were used to purchase property B, you need to do it in a rational and reasonable method.

The best methodology to determine the proper allocation would be the current market value of the properties.  You would know the value of property A based on the documentation you had to submit for the mortgage.  You would know the market value property B since it is a recent purchase.

Once you choose a method, you must maintain the same method.  You cannot change the allocation year by year for what would yield the best tax savings.  

IRS tips on rental real estate

Rental real estate and taxes per TurboTax

@Dave918 

[Dave918]

I have been allocating the repayments to whatever debt is smaller (property B in this case) so I can simplify things sooner by paying off the debt on B sooner so that I would only have debt left on A which is simpler. Splitting the debt between A and B is more complex so I have avoided that. Would this be acceptable to the IRS? Thank you

[PatriciaV · Accepted solution]

Yes, as long as you are consistent and can document how you applied the payments, whatever allocation system you choose is acceptable.