Can we do delayed financing on investment property, and is it tax deductible against same rental income

[prash]

Can we do delayed financing on investment property, and is it tax deductible against same rental income

I plan to buy rental property in cash.

Can i do immediately cash-out refinance next day after i buy it, and have it treated as acquistion debt for rental property , and use interest expenses to offset the rental income gains ?

[Mike9241]

definition of a cash-out refi

A cash-out refinance is a refinancing of an existing mortgage loan, where the new mortgage loan is for a larger amount than the existing mortgage loan, and you (the borrower) get the difference between the two loans in cash.   since your paying all cash it can't be a refi as the term is defined.   I also do not understand what you mean by using interest gains to offset rental income.

if you pay all cash for the rental property, at closing you'll pay certain fees and cost related to the purchase.

 yes, the next day you can take out a mortgage on the rental property and the interest would be deductible but you are likely to incur additional closing costs.    many of these are not deductible but would need to be allocated to the cost of the land and building. 

using cash to buy the property would result in any income being earned on it stopping. but the next day you have most or all of it back. so what do you do with it?   basically, you lose income for one day but also incur one day less of mortgage interest expense.

[prash]

My question was around the interest expense being an eligible deduction against rental income, when the interest is accured on a loan, which is obtained after buying the property in cash. Basically, loans are of different types. If delayed financing comes under acquistion bucket loan (for investment property), then it should behave fine. Otherwise, I think we can't use the interest expense as tax deduction.

[Carl]

If you outright purchase the property and pay for it with cash, then I seriously doubt financing the property later (even one day later) would be of any benefit. Your loan must be for the acquisition of the program, and a refi must be for refinancing the original acquisition loan on the property. Since you will not have any acquisition debt, I don't think any of the mortgage interest would be deductible at all.

Acquisition debt is a financial obligation taken on during the construction, improvement, or purchase of a primary or secondary residence. Thus, a home mortgage loan is an example of acquisition debt.

So if you're paying cash for the property, you own it free and clear. Then, if you take out a loan against that property the debt incurred is not acquisition debt, since you already "acquired" the property with cash.

@M-MTax I thought pub 936 addressed this. But I can't seem to locate it in that publication. I do find references to the debt being "secured" though. But I know I've read somewhere about acqusition debt - possibly in another pub. Can you clarify things here please?

[Opus 17]

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@prash wrote:

My question was around the interest expense being an eligible deduction against rental income, when the interest is accured on a loan, which is obtained after buying the property in cash. Basically, loans are of different types. If delayed financing comes under acquistion bucket loan (for investment property), then it should behave fine. Otherwise, I think we can't use the interest expense as tax deduction.

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I would say No, you can't deduct the interest as a rental expense.

I don't believe pub 936 and the definition of acquisition debt for a home mortgage apply here, since this is a commercial property.  Instead, I am thinking about the tracing rules and the business purpose of the debt.

For example:

1. Suppose you use a credit card or personal loan to buy property B.  That interest would be a deductible business expense, as long as you can meet the tracing rules (you can show that the specific debt is directly tied to a specific business purpose) even though the loan is not secured by property B.  If you started adding other purchases to that credit card or loan, you muddy the water and eventually lose the ability to trace the debt to the business purpose and would lose the deduction.

2. Suppose you own property A, and you borrow against property A to buy property B, and both are commercial property (rental, business, but not your personal residences.). The interest expense can be deducted as a business expense of property B, even though the loan is not secured by property B, as long as you can meet the tracing rules.  

3. Suppose you buy property B with cash, then take out a loan against property B to finance some property improvements.  That's a deductible business expense against property B because you can directly relate the debt to a business purpose for property B.

4. Suppose you buy property B with cash, then take out a loan against property B to buy some stocks and bonds.  The interest would be a deductible investment expense against your investment income, assuming you can meet the tracing rules, and the ability to deduct investment expenses is somewhat restricted since the 2018 tax reform (but is still available in some situations).  But the interest would not be a deduction against the rent from property B, 

Now, what you want to do if I understand is use cash to buy property B, then take out a loan against property B to pay yourself back, to pay back your cash account.  There's no business purpose to the debt, so the interest is not deductible against the income from property B.  Even though you end up in the roughly the same financial situation as if you had used your cash account as collateral to secure a mortgage on property B. 

[prash]

@Opus 17 

Thanks for your valuable inputs.

Is there a 90-day rule for investment properties , similar to primary residence properties. That says that, you can buy property in cash(to beat market offers, etc...) and do immediately refinance within 90-days, and it would be still considered as acquisition debt. I am 100% sure it applies to primary residence, but i am NOT clear if it applies to investment properties.

The whole reason for buying cash, is to close the deal sooner with impatient sellers, and then do refinance immediately in the background, and still be considered as acquistion debt.

[M-MTax]

One day? Seriously? Is there a reason you can't use escrow for this to delay the transfer?

[prash]

Can you explain what do you mean by escrow delay?

[M-MTax]

The title company should have a procedure where the cash and deed are deposited in escrow with instructions NOT to release the deed (transfer title) to you until you secure the financing. Sellers get their money and you get title at the same time the financing clears.

[Opus 17 · Accepted solution]

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@prash wrote:

@Opus 17 

Thanks for your valuable inputs.

Is there a 90-day rule for investment properties , similar to primary residence properties. That says that, you can buy property in cash(to beat market offers, etc...) and do immediately refinance within 90-days, and it would be still considered as acquisition debt. I am 100% sure it applies to primary residence, but i am NOT clear if it applies to investment properties.

The whole reason for buying cash, is to close the deal sooner with impatient sellers, and then do refinance immediately in the background, and still be considered as acquistion debt.

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I know there is a 90 day rule for residential acquisition debt, it's in publication 936 and I've also had an occasion to look up the actual statute (tax code) to check something.  I don't know of anything similar for commercial property, either affirmative or negative; i.e. I don't know of anything that definitely says there is and I don't know of anything that definitely says there isn't.

If there is no direct denial of the treatment, it might be reasonable to apply the residential rule and hope the examiner agrees with you if you are audited.  However, you may want to get advice from a professional that you pay for, and so the professional is responsible to you if they are wrong, besides just talking to strangers on the internet. 

[Critter-3]

You are mixing up the rules on  a HELOC  for  a personal  residential property  and any loan for a business use  property.   The Sch A has a limitation but not the Sch C, Sch E or any other business tax returns.  

The only rule you need to follow is the tracing rule where the loan is tied to the business property.   SO pay cash and put a lien on the property  anytime you wish  as all the interest is deductible on the business/rental no matter how it comes about. 

[M-MTax]

Agree with @Critter-3 .......... The interest deduction is set out in Sec. 163 and there doesn't seem to be the same limitations as there are for personal residential mortgage interest......qualified residence interest.....OR investment interest which is limited to investment income among other things.

[prash]

@Opus 17 

If we map the logic you mentioned, how the tax deduction will look like?

Just for an example:-

Usage of Funds:

Downpayment of an InvestmentProperty paid via all of the following, is eligible for interest deduction to offset rental income ?

Source of Funds can be:

1.)CashoutRefinance on primary

2.)CashoutRefinance on investment

3.)HELOC on primary 

4.)HELOC on investment

5.)MarginInterest 

6.)Credit Card Loan

Limitations:

Also is there a time limit, to show funds transfer made from loans to downPayment, to avoid losing eligibility?

Can i wait for 1-year for a better oppurtunity to arrive, and then use it for investment properties. Does that count for deduction?

Also, can i switch funds back and forth

For example, use it for:-

Stocks(First 6 months). 

Take Profit, and then invest in Rental Investment

Etc...

[Critter-3]

I highly recommend you seek out local professional guidance to get educated in the situations you have and not rely upon a nameless faceless public internet forum to make business decisions.  

[prash]

@Critter-3 

I talked to my CPA and he recommended not to use any tax deduction related to Cashout Refinance. I understand he may not have knowledge in that area, or haven't done it before. Hence looking for some answers here, and finding CPA who can validate or correct my assumptions and take from there. Goal is to get basic education here, and get it validated with CPA. Incase i find disparity, i will report back on this thread.