How do I enter a cash-out refinance on a rental property?

[jotheturtle]

Ohhhh... And do you happen to know where that rule comes from?

[Carl]

do you happen to know where that rule comes from?

IRS publication 535 Chapter 4 at https://www.irs.gov/pub/irs-pdf/p535.pdf

A bit of a synopsis:

Allocation of Interest

The rules for deducting interest vary, depending on whether the loan proceeds are used for business, personal, or investment activities. If you use the proceeds of a loan for more than one type of expense, you must allocate the interest based on the use of the loan's proceeds.Allocate your interest expense to the following categories

•Nonpassive trade or business activity interest

.•Passive trade or business activity interest.

•Investment interest.

•Portfolio interest.

•Personal interest.

[jotheturtle]

OK, I think I'm almost through this. So, to enter the Sch A deduction... After adding my 1098 under my rental (but only 54%!) do I then add the 1098 *again* under "Home loan deduction summary," but this time only including the 10% (or whatever) share of the interest that corresponds to the cash-out money I used for primary residence improvements? And every year, as I spend more money on improvements (new A/C, shed revamp, etc.) I may increase the % to match my cumulative use of the cash-out money towards primary home improvements? Or is there some other way to enter this in TurboTax?

[Carl]

but this time only including the 10% (or whatever) share of the interest that corresponds to the cash-out money I used for primary residence improvements?

Sounds to me like you got it.

every year, as I spend more money on improvements (new A/C, shed revamp, etc.) I may increase the % to match my cumulative use of the cash-out money towards primary home improvements?

Yes. Just keep in mind that the tracing rules apply on the flow of the money.

[jotheturtle]

All right! THANK YOU!!!!!!!!!!

Glad this will stay online to be useful for the next person in the same boat 🙂

[SamMac]

I have a similar situation as the OP except it's my primary residence and I refinanced twice in 2021. I originally tried filling out Table1 from IRS pub 936 but I think line 12 (or 11) is where I got lost (if you can tell me what figures I should be putting on those two lines, it would be a great bonus).

Anyhow, my mortgage principle balance (from the loan originally used to purchase the home in 2011) was $200,000 when I did a $500,000 cash-out refi in January 2021. I put the $300k excess funds into a savings account. 

In May 2021 my principle balance was $490,000 and I did another cash-out refi for $505,000. Again, the excess funds (~$15k) were put into a savings account. 

1) Can I deduct the full interest amount paid in 2021 from my original loan?

2) Do I, additionally, deduct 40% of the interest I paid in 2021 on the 1st refi ($200k/$500k)?

3) How do I calculate my % deduction for the 2021 interest on the last refi of $505,000?

4) Do I use the same % deduction (from question #3) for the interest I pay on the $505,000 loan for future years? 

Thanks in advance

Thanks in a 

[RaifH]

1) Yes, any interest paid on your original $200,000 mortgage would be deductible.

2) Pretty much, but you don't have to do the math. Enter Form 1098 as it appears and TurboTax will ask if it's a refinance and if you took cash out. Answer Yes to both. Enter the amount of cash you took out that you used to build, improve, or buy the house ($200,000) and select the I paid off this loan box and enter the information. 

3) You do not have to calculate it, TurboTax will based on the entries. For the second refinance, you will enter the balance as of January 1, 2022. The home acquisition debt will still be $200,000, which represents the original amount you used to buy the home since none of the refinanced money was used on the home.

4) In future years, the IRS has determined that you pay off the non-deductible home equity debt before reducing the deductible interest. This is a good thing because it means you will still get the same interest deduction until the $300,000 of money you did not use on the home is paid off. Only then will your principal payments start to reduce the deductible mortgage interest. You will continue entering $200,000 as the home acquisition debt (assuming the entry fields don't change much). As your principal is whittled away, the deductible portion of your mortgage is a larger percentage of the total mortgage interest you are paying.

@SamMac

[SamMac]

Thanks for the detailed and quick reply. I inputted as you said and it looks very close to what I was expecting. I tried manipulating the numbers to see exactly how TT calculated it (because I like knowing the reasoning) but couldn't determine exactly how TT did it. I'll just rely on TT to continue tracking it.