I refinanced my primary residence and used the funds to help purchase a rental property. Can I deduct the interest on this loan from the rental income?

[Anonymous_]

Yes, you can use the tracing rules and deduct the interest paid provided the proceeds of the loan are used for a rental activity.

See https://www.irs.gov/instructions/i1040se#idm140630720082288 and  https://www.irs.gov/publications/p535

[Carl]

Wait a minute. What do you mean by you used the funds to "HELP" purchase a rental property? Did you use those funds for the down payment and then took out a separate loan for the rental? What exactly did you use the funds for?

[NCperson]

Tracing rules cover interest used for different purposes; however, residential mortgage debt is carved out of the reg and covered differently:

2) Treas. Reg. §1.163-8T(a):  (6) Special rules—(i) Qualified residence debt. [Reserved] - the rules are not part of the reg but part part of Publication 936

If you look at Publication 936,  there are two sets of rules that must be met for the interest to be deductible

"Part I:

Generally, home mortgage interest is any interest you pay on a loan secured by your home (main home or a second home). The loan may be a mortgage to buy your home, or a second mortgage. You can deduct home mortgage interest if all the following conditions are met.

• You file Form 1040 and itemize deductions on Schedule A (Form 1040).
• The mortgage is a secured debt on a qualified home in which you have an ownership interest. (Secured Debt and Qualified Home are explained elsewhere in the publication)

Note. Interest on home equity loans and lines of credit are deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan. As under prior law, the loan must be secured by the taxpayer’s main home or second home (qualified residence), not exceed the cost of the home, and meet other requirements."

Note that your approach will fail the test in red font and most critically the bolded part of the red font.

Part II

This part of the publication discusses the limits on deductible home mortgage interest. These limits apply to your home mortgage interest expense if you have a home mortgage that doesn't fit into any of the three categories listed at the beginning of Part I under Fully deductible interest, earlier. Your home mortgage interest deduction is limited to the interest on the part of your home mortgage debt that isn't more than your qualified loan limit. 

I am not going to write out the rest of Part II but it pertains to the new $750,000 loan limit, the prior $1,000,000 loan limit and grandfathered mortgaged.

[Anonymous_]

The security for the debt has applicability only with respect to qualified residence debt, which interest might otherwise be deductible on Schedule A (hence, the reason that Schedule continues to be raised in the rules, regs, and publications). 

The security for the debt is irrelevant if the proceeds are used for business or investment purposes.

[Anonymous_ · Accepted solution]

@anon30 You marked the wrong answer as a solution.

If you choose to treat the debt as not secured by your home, you can deduct the interest paid to the extent you use the proceeds of the loan for business purposes (including rental properties).

See https://www.irs.gov/publications/p936#en_US_2019_publink1000229898

[Anonymous_]

@anon30 That is fine - except - NCPerson's post is still marked as a solution and it is wrong. You can undo this by clicking the three dots in the upper right side of the post and clicking "Not the solution". Thank you!

[kevin5]

Just to put it in full context, here is the entire IRS Quote Tagteam referred to.   That solved it for me!

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 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. This may allow you, if the limits in Part II apply, more of a deduction for interest on other debts that are deductible only as home mortgage interest.