HELOC tracing rules

[globallegend]

Please I have a situation where I applied for HELOC about $100k to acquire a new construction rental property but the construction is delayed 6months. The bank is offering some really attractive rates for the first 6 months after HELOC closing so I am looking at closing and then investing the money in a high yield CD for the first 6 months and also start making payments early towards the HELOC to get a head start on payback. Please can you advice on how the interest tracing rule would work when I eventually use the money to close at the end of the 6 months wait. I am assuming that I will deduct the interest paid in the first 6 months against the gains on the CD which counts towards personal income(this is deductible right?), and then all the interest paid after closing date will be traced and applied as expenses or can you advise on how it will be treated after closing on rental property. So we are in April, lets assume rental property closing is in October on the rental property and I put the $100k HELOC in a CD that earns $3k in 6 months and paid $2900 in interest in the 3 months. From October to December after closing I pay another $3000 in interest on the HELOC after rental property closes with money used as down payment, Can you please help with how it will be traced.

[Mike9241]

for the year you borrow the money and put it into a CD you must include an election with your return not to treat is as secured debt. The election is under reg 1.163-10T(o)(5)(i). it is not  revocable without IRS permission. the reason this election is necessary is that interest on HELOC, secured by the residence, and not used to improve the property, is not be deductible.

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since the money first goes in  CD. the interest expense for those 6 months would be investment interest expense deductible using form 4952 only if you itemize and only to the extent that investment income for the year exceeds the interest expense for those 6 months. Any excess is a carryover. after that the tracing rules say when the proceeds of a loan are shifted to a new use, the interest on that debt must be reallocated to that new use. this would occur when the CD is cash in and the proceeds go directly to purchase the rental. 

(another reason for the original election. without it the interest would not be deductible as an expense of the rental property)

example

Election statement under Temp. Regs. Sec. 1.163-10T(o)(5) to treat debt as not secured by a qualified residence

Taxpayer name: J Soc. Sec. No.: 999-99-9999 Form 1040, tax year ending 12/31/XX

The taxpayer elects to treat $$$$$$ of home-equity debt, the proceeds of which were used to purchase a CD as investment interest. The interest on this debt for the term of the CD was $$$$$$$ and is claimed on form 4952.

Subsequently the CD matured and the proceeds were used to purchase rental property.  Interest paid on the debt has been reallocated to the new use and was $$$$$ 

[globallegend]

Thanks a lot for the detailed response. Please can you clarify. I have a couple of followup questions.

1.  I am trying to understand the election to not treat as a secured debt. Is this because the Tax and Jobs act under Pres. Trump no longer allows general deductibility of HELOC interests and the only way to make it deductible towards rental property or CD investment is by making this election notice. And I am guessing this notice is just a notice I attach to tax return filing, correct?

2. When I file, would the HELOC interest paid in the 6 months when I have in CD be deductible towards other investments like stocks too. If the CD yield is less than the HELOC interest paid, could the extra interest be applied towards another stock investment income to reduce the tax on that income? Can extra negative interest payment carry over to the following year on the HELOC interest used towards CD?

3. Also trying to understand what you said about revoking the election only with IRS permission. So are you saying that if for instance I decide to use the HELOC to do upgrade on the same securing property. Is that an example of a scenario that might propmpt revoking the election?