I want to do a cash-out refi on my primary home and use that cash for purchasing an investment property. Say, I currently owe 100k on my property and take 50k cashout. Is the interest on cashout portion (50k) considered a rental expense (on schedule E) ? What amount can I deduct for mortgage interest (on line10 of schedule A) ?
When you borrow funds, the funds and related interest are traced to activities that utilized the funds within 30 days of the borrowing. In your case, all your borrowings on the HELOC were used to acquire rental property. Therefore, the interest paid on the debt could be considered passive activity interest or alternatively you could treat it as home mortgage interest within the $100,000 limitation or a combination thereof.
If treated as passive activity debt, the interest is deductible against the rental income produced by the acquired property. The limitation of $100,000 on home equity debt does not apply, as the debt was not incurred for personal purposes.
Interest paid falls into six categories:
1. Investment interest
2. Trade or business interest
3. Passive activity interest
4. Home mortgage interest
5. Student loan interest
6. Personal interest
Passive activity interest is interest paid by the borrower to finance a passive activity. A passive activity is generally a rental activity such as rental real estate reported on Schedule E.