If I buy a rental for cash and then finance the property the following year, can I deduct the mortgage interest on the property after getting the loan?

[Anonymous_]

"...can I deduct the mortgage interest on the property after getting the loan?"

It actually depends upon how you use the proceeds of the loan. 

See https://www.irs.gov/instructions/i1040se#idm140630720080112

If you use the proceeds for more than one purpose, you have to allocate the interest based on the use of the loan's proceeds.

See https://www.irs.gov/publications/p535#en_US_2018_publink1000243081

[Carl]

can I deduct the mortgage interest on the property after getting the loan?

No, you can not. I've spent some time looking and I can't find the specific publication I want to reference for you. But in order for the interest to be deductible the loan *must* be for the specific purpose of purchasing, acquiring, expanding or improving the rental property. Since you paid cash for it up front you have already purchased and acquired the property. I seriously doubt you would be using the borrowed money to improve or expand the property.  Therefore not one single penny of interest or any of the closing costs would be deductible on SCH E.

[Anonymous_]

The publication reference can be found at the link below and it essentially applies to home mortgage interest (hence the title, "Home Mortgage Interest Deduction"). 

Again, if the proceeds are utilized in the current rental activity, a different rental activity, business or other type of investment activity, the interest paid on the mortgage may be deductible via tracing.

https://www.irs.gov/publications/p936#en_US_2018_publink1000229891

[NCperson]

@dak9779 - suggest focusing on this part of the link as provided by @Anonymous_ 

Mortgage that qualifies later.

A mortgage that doesn't qualify as home acquisition debt because it doesn't meet all the requirements may qualify at a later time. For example, a debt that you use to buy your home may not qualify as home acquisition debt because it isn't secured by the home. However, if the debt is later secured by the home, it may qualify as home acquisition debt after that time. Similarly, a debt that you use to buy property may not qualify because the property isn't a qualified home. However, if the property later becomes a qualified home, the debt may qualify after that time.

Mortgage treated as used to buy, build, or substantially improve home.

A mortgage secured by a qualified home may be treated as home acquisition debt, even if you don't actually use the proceeds to buy, build, or substantially improve the home. This applies in the following situations.

1. You buy your home within 90 days before or after the date you take out the mortgage. The home acquisition debt is limited to the home's cost, plus the cost of any substantial improvements within the limit described below in (2) or (3). (See Example 1, later.)

2. You build or substantially improve your home and take out the mortgage before the work is completed. The home acquisition debt is limited to the amount of the expenses incurred within 24 months before the date of the mortgage.

[Carl]

@Anonymous_ you keep focusing on "home" mortgage interest. A home loan is not secured by rental property if that's what the property is at the time of purchase. (rental property) It's a type of business loan or investment loan. (What it's called depends on the bank, but for rental property they're basically the same.)

Don't confuse this with what happens when you convert your primary residence (which has a home loan on it) to a rental.

[Anonymous_]

@Carl I am actually focused on tracing, not "home mortgage interest". I did not write the post immediately above your most recent post, @NCperson wrote that post.

The rationale behind that post, I suspect, was the result of your focus on the "buy, build or substantially improve" language (for which you stated you could not find a reference) in Publication 936 and that publication relates to home mortgage interest. The "buy, build or substantially improve" language has relevance but it is not the only test of deductibility of interest payments; tracing rules apply.

[Anonymous]

the IRS has what is referred to as tracing rules.  whether any of the interest is deductible depends on the use of the proceeds.  since you paid cash for the property before the loan, it could not be argued that the loan was used to purchase the property.  However, if you use the loan proceeds to make improvements and repairs on the property then it would be deductible on schedule E.  you could use the proceeds to buy another property.  if the proceeds just go back into your account, no deduction.     used to buy stocks - investment interest on schedule A.    a personal trip - no deduction.       

[NCperson]

@Anonymous - I have found this thread fascinating - please look at this link where the IRS specifically says 'tracing' is not deductible .. See example #2. 

https://www.irs.gov/newsroom/interest-on-home-eq[product key removed]-still-deductible-under-new-law

Example 2: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home.  The loan is secured by the main home. In February 2018, the taxpayer takes out a $250,000 loan to purchase a vacation home. The loan is secured by the vacation home.  Because the total amount of both mortgages does not exceed $750,000, all of the interest paid on both mortgages is deductible. However, if the taxpayer took out a $250,000 home equity loan on the main home to purchase the vacation home, then the interest on the home equity loan would not be deductible. 

[Anonymous_]

@NCperson Your link does not seem to work but the one below does and, I believe, it is to the same web site.

https://www.irs.gov/newsroom/interest-on-home-equity-loans-often-still-deductible-under-new-law

However, I can find nothing on that page where "the IRS specifically says 'tracing' is not deductible".

Note, in addition, that the IRS web site here is specifically addressing home mortgage interest (main homes, second homes, vacation homes, et al) that would otherwise be deductible as itemized deductions on Schedule A. 

[NCperson]

while I appreciate there is nothing that says tracing is not deductible, I thought the way it works is unless the IRS says it is deductible, it's not.

let's see what @Anonymous  responds with 

and yes, you are referencing the link I was reading.....

and my apologies as I restarted this conversation against the wrong thread...... there was a discussion a few weeks back with a tax payer who had a novel approach to refinancing his primary and investment properties - but the issue is the same - 'tracing'

[Anonymous_]

---

@NCperson wrote:

while I appreciate there is nothing that says tracing is not deductible, I thought the way it works is unless the IRS says it is deductible, it's not.

---

Exactly and tracing is valid; the interest is deductible.

See https://www.law.cornell.edu/cfr/text/26/1.163-8T

See also https://www.therealestatecpa.com/blog/who-said-you-cant-deduct-heloc-interest-interest-tracing-expla...

See further https://www.taxcpe.com/blogs/news/tracing-rules-that-apply-for-deductibility-of-interest

Do an internet search with the search term "interest tracing" (or similar terms) and you will get an ungodly number of hits. I cannot believe this is actually being disputed on this board; tracing is a rather old and well settled concept.

[recuerdos]

So If I do a cash out refi on my rental, get money out to buy another rental, the interest would be tax deductible right?

What if I bought rental with cash and then do cash out refi immediate on another rental to replenish some of my cash?

[AmyC]

@recuerdos  The safest thing to do is get a loan, buy a house, have a paper trail. It does not matter which house or where the loan comes from. You want to show that you needed money to buy the house and that was the money. Replenish your money is not a deduction.

There are extenuating circumstances and positions and gray areas everywhere.