Use HELOC from my primary house to buy a rental property. Shall I deduct the HELOC interest as primary home mortgage interest or as expense for the rental property?

[view2 · Accepted solution]

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 incurred for personal purposes.

If you use part of the HELOC for personal purposes, that interest would be allocated to home mortgage interest on Schedule A within the $100,000 limitation.

Home Equity Debt  

http://www.irs.gov/publications/p936/ar02.html#en_US_2016_publink1000230008 

[Dan126]

Does anyone know how this will play out with the new tax laws?

[michinori-kaneko]

bumping Dan126's comment

[haskeli]

if you are not filing a Schedule A you probably would want to deduct against rental income. Anyone know where to enter that in Turbo Tax?

[John F]

You wrote:  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 …  If treated as passive activity debt, the interest is deductible against the rental income produced by the acquired property. 

I clicked on your provided link and researched this matter in the IRS Publication 936, “Home Mortgage Interest Deduction.”  On the front cover and in numerous other places in the official IRS publication it clearly states any HELOC interest expense paid on items not to “buy, build, or substantially improve your home” meaning your primary residence – this interest is no longer deductible for tax years 2018 and forward.

As a CPA, I respectfully disagree to your advice on deducting HELOC interest expense against rental income (or deducting anywhere else on a return) if the purpose of the HELOC debt was not for the “buying, building, or improving” of your primary residence.

[Critter]

The interest should go on the Sch E due to the tracing rules... the HELOC was used to buy the rental which did make it for the acquisition of the rental property.  Be prepared to support that assertion in case of an audit since the 1098 has your personal residence listed on it and not the rental.

[Critter]

Per @TaxGuyBill   in this thread :  https://ttlc.intuit.com/community/investments-and-rental-properties/discussion/use-heloc-from-my-pri...

By default, it is Home Equity Debt (which is not deductible for 2018).  There is an "election" to make it not Home Equity Debt and to 'trace' the amount for what it is used for.  That "election" is made by just entering the deduction for what it was used for (such as a rental).  See §1.163-10T(o) for the legal gibberish.

[demens13]

---

@John F wrote:

You wrote:  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 …  If treated as passive activity debt, the interest is deductible against the rental income produced by the acquired property. 

I clicked on your provided link and researched this matter in the IRS Publication 936, “Home Mortgage Interest Deduction.”  On the front cover and in numerous other places in the official IRS publication it clearly states any HELOC interest expense paid on items not to “buy, build, or substantially improve your home” meaning your primary residence – this interest is no longer deductible for tax years 2018 and forward.

As a CPA, I respectfully disagree to your advice on deducting HELOC interest expense against rental income (or deducting anywhere else on a return) if the purpose of the HELOC debt was not for the “buying, building, or improving” of your primary residence.

---

The IRS text says:

deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan

How can this be interpreted in terms of BUY? How can you buy the home that is used to secure the loan? Can you buy another home?

[KrisD15]

If you go to close on a house and sign papers to finance this house, you just took out a loan to buy a home and that same home is used to secure the loan. 

[potsticker]

hi John, i saw  your post on deducting primary HELOC interest when the HELOC was use to purchase a rental property. i agree with you that the irs rules says this interest is not deductible.

for me, i am using the primary HELOC to build an ADU on the same lot as my primary residence, would that qualify it as "improve primary residence" and hence the interest would be deductbile?

thanks for any pointer.

Frank

[DavidS127]

If the accessible dwelling unit you are building is considered a part of your home, the interest is deductible to extent the proceeds of the HELOC were used for the ADU.

See the section of IRS Publication 936 at this link for more details.

@potsticker

[AmeliesUncle]

@potsticker   As David pointed out, it depends on what the ADU is used for.  If it is used as your Principle Residence, it is deductible as an Itemized Deduction on Schedule A.  If it used as a rental property, it is deductible as rental interest on Schedule E.  If it is used for something else ... it depends on what the something else is for.

[potsticker]

Hi @DavidS127  and @AmeliesUncle

Thank you for replying to my post and referring to the publication 936.

To give some concrete number, My primary loan was originated in 2013 so it is grandfathered to have a $1M loan limit for interest deduction, it is 765k.
My HELOC was setup in sept 2017. (before the new tax law)
The HELOC proceed 200k will be spend in 2020. (after the new tax law)

Could the HELOC proceed interest be allowed to deduct in full if HELOC+primary loan stay below $1M?

update: I read more on this publication 936, my HELOC use would be considered as home acquisition debt after 12/15/2017.
Using table 1 Part 1 to calc Qualified loan limit.
The table calc shows that HELOC proceed (home acquisition debt) incurred after 12/15/2017 does not get adds to the qualfied loan limit, is that correct? =(

Another thought is to refinance the primary+HELOC into 1 new primary loan (965K), could that allow me to deduct interest on this entire loan if it is still below $1M? (since the original loan is from 2013)
thanks so much for your thoughts/discussion.

Frank

[AmeliesUncle]

The new loan amount will be subject to the $750,000 maximum limit.  Refinancing it by combining it with the old loan won't change that.