Can interest expense deduction be changed from personal property to rental expense years after initial refi date?

[knazifi]

Refi with cash out used to purchase a rental property was done years ago. Full interest expense was reported as schedule A personal property interest deduction in previous tax returns. Can I change and re-allocate the interest portion of cash out as rental expense without going back and filling adjustments to my previous tax returns? Would I be exposed to IRS audit if I make the change starting with 2017 tax return?

[TomYoung · Accepted solution]

If you can reliably trace the cash out from the refi to the purchase of the rental property then the interest is business interest reportable on Schedule E, and has been all along.  Depending on the circumstances you may have been over reporting Schedule A interest.

You might want to go back and amend previous years to see the results, though only the last 3 years are open to amending if you are claiming a refund.

Schedule E is the appropriate place to claim the interest.  Whether changing from prior years' practices in 2017 will draw the attention of the IRS I can't say, but the change will more correctly reflect the rental's income or loss.

Tom Young

[TaxGuyBill]

If I remember correctly, Home Equity Debit is sort-of optional for the Tracing Rules (by default, it is not part of the Tracing Rules, but you can elect into it).  You can treat it as Home Equity Debt (up to $100,000 of loan), or it could be treated as Rental Interest.

I think it is allowed to change to from treating it as Home Equity Debt to Rental Interest.  In other words, amending would not be necessary UNLESS the debt was over $100,000.  However, the reverse is NOT true.  Once you start treating it Rental Interest, you can't change it.