Complicated HELOC Deduction With Primary/Rental

[fastboats]

Hi --

Got a complicated HELOC tax deduction question. The internet research I've done doesnt seem to really align with our situation.

We currently reside in our primary residence since 2018.

We just bought a new home in April of this year and we are planning a major 10 month renovation starting early next year. In the meantime, we have some renters in there until construction starts.

We will move into our new home once construction finishes. At that time we will rent out our current primary residence.

We have a lot of equity in our current primary residence and are considering taking out a HELOC/equity loan to help pay for some of the construction costs in our new home. In that way, the funds would be used to "buy, build, or substantially improve [our] home.” 

Question is -- once we eventually move out of our current primary residence (which would then have a primary loan and a HELOC loan attached), could we write off interest from the HELOC as a rental expense too?

[Critter-3]

Question is -- once we eventually move out of our current primary residence (which would then have a primary loan and a HELOC loan attached), could we write off interest from the HELOC as a rental expense too?

NO ... the HELOC was used for the new primary residence and the tracing rules means it continues to be applied to that property ... it cannot be used for the converted rental at all.  

[NCperson]

Let's restate the case for simplicity

House A is the current MAIN home and has a lot of equity.  It will eventually be a rental.

House B is the current SECOND home, will have major renovations and will eventually be the PRIMARY Home.

if a HELOC is a lien against Property A, is the interest tax deductible?  NO.  Because the dollars need to be used on Property A to buy, build, or substantially improve [our] home.

Page 9:  Home acquisition debt is a mortgage you took out after October 13, 1987, to buy, build, or substantially improve a qualified home (your main or second home). It must also be secured by
that home

So taking out equity in the form of a HELOC from Property A and not using the money on the very same property would not qualify as 'aquisition debt'.  So it is NOT tax-deductible. 

But what about when Property A becomes a rental? is the Interest from the HELOC tax reductible on SCHEDULE E? NO.  Look at the definition of 'qualified home' 

Page 4: 

The interest you pay on a mortgage on a home other than your main or second home may be deductible if the proceeds of the loan were used for business, investment, or other deductible purposes. Otherwise, it is considered personal interest and isn't deductible.

Since the proceeds of the loan were not used for business, investment or other dedutible purposes, the interest is not deductible on SCHEDULE E.  

Best bet would be to take out a home improvement loan / construction loan on Property B to preserve the tax dedutibility of the interest. You'd have to run the numbers to see if the higher interest rate related to a mortgage on Property B, net of the tax savings is a better deal than taking out a HELOC that is not tax-deductible on Property A. 

https://www.irs.gov/pub/irs-pdf/p936.pdf