Thank you for your response but I'm not convinced. 2019 version of Pub 936 says the following about home equity loans:
"Interest on home equity loans and lines of credit are deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan. As under prior law, the loan must be secured by the taxpayer’s main home or second home (qualified residence)..."
In part II of Pub 936 home acquisition debt is defined as "a mortgage you took out after October 13, 1987, to buy, build, or substantially improve a qualified home (your main or second home). "
If I read in between the lines, I'd say Pub 936 has a very broad definition of mortgage, i.e., it includes other forms of debt such as home equity loans or HELOCs. I'd also argue that the home equity loan would replace my traditional mortgage so they are serving the exact same purpose, i.e., purchasing my home. That being said, it seems like that's all moot because my rental is not a "qualified home", i.e., it's not my main or second home.
I fill out Schedule E for my rental income/loss. Lines 12 and 13 on Schedule E are:
12. Mortgage interest paid to banks, etc. (see instructions)
13. Other interest
The schedule E instructions says among other things:
"In most cases, to determine the interest expense allocable to your rental activities, you must have records to show how the proceeds of each debt were used."
"Interest you paid as part of your rental real estate activity is not subject to the limitation on business interest unless your rental real estate activity is a trade or business."
"If you have a mortgage on your rental property, enter on line 12 the amount of interest you paid for 2019 to banks or other financial institutions."
The instructions don't rule out any specific form of debt allocable to your rental activities. It does specifically say mortgage interest is deductible, but as I argued above regarding Pub 936, I think the IRS' use of the term "mortgage" includes all forms of home acquisition debt including home equity loans. Moreover, I'd argue the use of the home equity loan is equivalent to the debt I'd incur if I refinanced my traditional mortgage. I'll also note that I don't consider my managing activity to be high enough to be considered a business activity so for tax purposes it is an investment.
I haven't convinced myself that the home equity loan interest is deductible for my specific case, but based on the IRS pubs I'd say it weighs in favor of it being deductible. I'd appreciate if someone could provide a convincing argument and/or proof one way or the other.
