Primary home cash out refinanced in 2018. Converted to rental later in 2018. No refinance after rental conversion. Can i deduct all interest paid as expense?

[Customer1001]

I refinanced my primary home in feb’ 2018 with a cash out.  Later during june’18, i converted the primary home to rental but did not use the cash out for home improvement. I did not refinance after i converted to rental in june’18. For the calculation of mortgage interest as expense, IRS publication only discusses the scenario of cash-out refinancing done after rental conversion.Since i started the rental with the cashout refinanced amount, can i consider the entire mortgage interest paid on it as my expense on the rental property?

[Leonard]

No, you can not consider the total mortgage interest as an expense against the rental.  You can only claim as an expense the mortgage interest paid after the property was converted to a rental. Mortgage interest paid prior to the conversion may be deducted on Schedule A if you itemize your deductions.

[Customer1001]

Thanks for the response! I guess i was not clear in my question. I will try to walk through the scenario. My primary home had an original loan amount of  100k. I did a cash out refinance to 900k in feb 2018, when the house was still my primary home. But during june 2018 i bought a new primary home and converted the first home as rental. I did not do any refinance after i converted to rental. Can i claim the interest paid on 900k loan from june thru december as the expense? Or am i limited to only the interest paid for the original loan amount of 100k? Since at the time of conversion to rental, i had a loan of 900k ( inspite of cashout refi from100k when it was a primary home), i am assuming that i can count all of interest on 900k ( june thru dec) as expense on rental and claim loss. Please let me know.

[ColoRock]

Did you ever get an answer? I have a similar situation. I did a cash-out refinance on my primary home a couple years ago. Used the proceeds for personal use. This year I converted the same primary home to a rental. So, same question: since the cash out for personal use happened before the home was converted to a rental, after it is converted is all the interest on the mortgage a deductible expense, or do I have to make an adjustment for the prior cash out?

This is all a timing issue...the IRS is VERY clear if you were to do this after a rental unit is place into service. Nothing on conversions where this occurs while your primary residence.

[WendyN2]

@Customer1001 Yes, you can take the interest as a deduction on your Schedule E, Rent/Royalty Income & Expense Form, from the date it was actually a rental (you were no longer living there and have listed it as for rent, or of course, have already signed a lease agreement - this obviously is showing that you are not trying to write off the interest during a "down time" of the conversion from residence to rental. 

If you moved out and converted as of July - as you were converting during June (per your statements above) - for that first year. If this is not what you did, then it would definitely be worth it to amend your return(s) from 2018 and 2019!  Even if in those years you are not seeing the full benefits (for whatever other reasons due to your other tax items), this is being recorded and carried forward from year to year and when you sell the property (if you ever sell), you will then be able to reap some of these "disallowed losses" that you will be carrying forward from 2018 until you do sell it. 

[edwardgibbs]

I have the same situation - cash out refinanced my primary residence in 2017, then later in 2017 converted it to a rental.  I would like to get a clear statement specifically about the deductibility on Schedule E of interest on the portion of the loan that was used for personal purposes.  As others have said the IRS guidance all refers to refinance after conversion, we refinanced before conversion.  Wendy says to deduct the interest, but she never specifically addresses interest on the personal use portion of the loan proceeds..  Is anyone willing to clarify the rules here, please?  Or is it a matter for the tax court to decide?

[RobertB4444]

The mortgage interest on the loan while it is your personal residence is deductible as part of your itemized deductions on schedule A.  The interest is limited by the size of the loan (the maximum amount of interest is on a home loan is the interest on the first $750,000 of indebtedness) but otherwise is fully deductible if it is secured by your home.

So, for your scenario, the interest on the original loan is deductible as is any interest on the loan up to the point of conversion to a rental.  All of that goes on schedule A.  Then any mortgage interest after it is converted to a rental is deducted on schedule E.

@edwardgibbs 

[edwardgibbs]

Thanks, but the question was whether ALL of the interest is deductible on Schedule E in following years if some of the loan proceeds were used for personal uses.  The IRS has clear guidance for the case where you refinance a rental property and use the proceeds for personal use, but is mute on the case where you refinance a primary residence, use some of the proceeds for personal use, and then later convert that property to a rental. 

I'm guessing that is because the tax court has not encountered that situation yet and thus there is no guidance.

[DianeW777]

No, not all of the mortgage interest is deductible. 

• '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.'

In general, you allocate interest on a loan the same way you allocate the loan proceeds. You allocate loan proceeds by tracing disbursements to specific uses.

More information can be reviewed in IRS Publication 535, Chapter 4. (IRS Publication 527 refers you to 535).

@edwardgibbs