Deduct interest in "Personal Deductions and Credits" or "Rental Expense by following IRS publication 535, section 4 Interest tracing guideline"?

[HL1]

When we first purchased the rental property, we used the Line of Credit from our primary residence as down payment and secure a mortgage using the rental property.  We deducted interest payment as Rental Expense in 2016 - how the loan is secured and used. However, we refinanced the rental mortgage secured by primary residence since the interest rate is lower with primary residence  We received two 1098(s).  Both indicate the Primary residence is the property securing mortgage. 

Can we still deduct the mortgage interest as rental expense following Interest "Tracing Rule" in IRS publication 535, section 4 Interest, which states "In general, you allocate interest on a loan the same way you allocate the loan proceeds. You allocate loan proceeds by tracing disbursements to specific use." OR should we deduct based on how the loan is currently secured - in this case is refinanced to primary residence so deduct in the "Personal Deductions and Credits" section?

[MichaelL1 · Accepted solution]

Yes, you can continue to take in on the Sch E.  Look at research below from the Pub 535 and Pub 936.

With the standard deduction for married going to $24,000 in 2018, I like the idea of going directly to the rental when deducting this, as you may not get the full benefit on the return as an itemized deduction in future years. 

"The property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. The interest is usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. For more information see Pub 936. " Source Pub 535

"Choice to treat the debt as not secured by your home. You can choose to treat any debt secured by your qualified home as not secured by the home. This treatment begins with the tax year for which you make the choice and continues for all later tax years. You can revoke your choice only with the consent of the Internal Revenue Service (IRS). You may want to treat a debt as not secured by your home if the interest on that debt is fully deductible (for example, as a business expense) whether or not it qualifies as home mortgage interest."

Source Pub 936 page 4 first column.