Investment Property/Primary Residence Tax Deduction

[TaxComm101]

Hi All - We refinanced our primary home (Home #1)  and used all of the Cash-Out as a down payment on our new primary home (Home #2) . We now live in Home #2 and are trying to decide what to do with Home #1, rent or sell? If we rent Home #1, is the interest deduction credited to that home even though it will be an investment property and the Cash-Out was used as a down payment on our new primary home (Home #2)?

Thanks in advance for your help.

[Critter-3]

Since you had a mortagage and refinanced instead of doing a separate HELOC  you now have one mortgage that need to be allocated between the Sch E for the rental and the Sch A for the personal portion.  

[NCperson]

@Critter-3 - can we go back on that answer as I wasn't following. 

Assuming no rental, there are two homes. There was a cash out refi on Home #1, but none of the proceeds were used to built or improve THAT residence, so why would the cash out portion be tax-deductible at all? Only the 'aquisisition debt' would be tax deductible.  

With regards to Home #2, that cash out refi money is not aquisition debt on Home #2 as it not a debt on Home #2 - it is equity. 

Once Home #1 is a rental, why wouldn't all the interest related to the mortage on Home #1  be deductible on Schedule E?  What interest end up on Schedule A, other than the interest on Mortgage #2 (if there is one) used to aquire Home #2? 

thanks in advance!

[Carl]

As it stands right now with both properties are personal use. One is your primary residence and the other is your 2nd home.

The cash out amount on home#1 is not debt that will give you a reduction of any tax liability at this time. Only the interest on that portion of the loan that paid off the original loan is deductible.

Example:

At the time of the refinance you owed $100,000 on Home#1. You refinanced for $150,000, paid off the original remaining balance on the first loan and cashed out $50,000. Of your new $150,000 loan the interest on only the first $100,000 is deductible on SCH A as an itemized deduction. So only 66.6% of the interest paid on that new loan is deductible.

The remaining 33.3% of the interest on the $50K cash out isn't deductible anywhere because you did not use that money to buy, build, or improve the home that was used to secure the loan.

That's how it stands "right now".  Things change quite a bit if you move into Home#2 as your primary residence, and then convert Home #1 to a rental.

[NCperson]

@TaxComm101 - I agree with what @Carl wrote.

once Home #1 is rented, ALL the interest is deductible on Schedule E.  Nothing is deductible on Schedule A.  This is the only way the interest related to the cash out can be deductible.  

One small point, technically, assuming Home 1 is a 2nd home (and not rented out), the interest on the 'aquisition debt' (the balance of the loan prior to the cashout) remains deductible interest while the cashout does not qualify as deductible interest.  The nuance is that the IRS assumes taht over time the cashout peice of the mortgage amortizes first.  So over time, the interest that is not deductible keeps going down while the deductible peice (from the aquisition debt) remains constant until the cash out part of totally amortizes. 

[TaxComm101]

Carl,

Thank you for your quick and thorough response to my question. I am new to this forum and wasn't sure that anyone would even care about my question, much less answer it with lightning speed. 

Have a great day!

[TaxComm101]

NCperson -

Thank you for your quick and thorough response to my question, too.  You and Carl have made my day and helped ease some stress in our household.

Have a great day!