Hello,
I would like to understand the tax implications. I have home in Texas that I have been renting out to tenants for many years. My wife and I live in an apartment in CA. This year we decided to do a cash out refi since interest rates are so low so we can put at least a 20% down on a primary home in CA.
We don't have a home in mind, but the lender who will work on our CA loan mentioned to us that it would be better to get the cash-out refi done first to be ready once we find a home in CA, but just keep the bank in an account and don't touch it.
1) Since we don't have a home yet, what are the tax implications ? The cash that we will receive is it considered taxable income? Do we have to pay taxes?
2) Now that the home in texas has been refinanced at a lower interest rate, how do I update turbo tax so it know that it understands the changs that happened so I can deduct the right deduction?
1) Since we don't have a home yet, what are the tax implications ? The cash that we will receive is it considered taxable income? Do we have to pay taxes? A LOAN is never taxable income.
2) Now that the home in texas has been refinanced at a lower interest rate, how do I update turbo tax so it know that it understands the changs that happened so I can deduct the right deduction? You will enter the mortgage interest but you will need to prorate it ... the HELOC portion going to the Sch A and the rental portion to the Sch E.
A loan is never taxable income as long as you pay it back.
Because the house you refinanced is a rental property, deducting the interest on the refinance loan is problematic to say the least. At best, only part of the interest is deductible as a rental expense, that will be the part that is attributable to the original debt on the property before the refinance. For example, if the remaining balance on the mortgage was $50,000 and you refinanced for $100,000, then at most, 50% of the interest is deductible on schedule E as a rental expense. However, if you are audited, you will need to show the IRS a paper trail that proves that the portion of interest you declare as a rental expense can be directly tied to the rental property.
The interest that you pay on the cash out portion of the mortgage will never be deductible under any situation. As a cash out home equity loan, equity interest is not deductible on schedule A as an itemized deduction. Only interest on loans that are used to buy, build, or substantially renovate your personal home may be deducted on schedule A. However, even after you buy a house with that money, that interest is never deductible, because in order to deduct a home mortgage the loan must be secured by the property in question. Since this refinanced loan will not be secured by the house you eventually buy, the interest will never be deductible.
Once you purchase your new primary residence, you might be able to finance or refinance it in such a way that you pay off the equity part of the loan on the rental property and so that the mortgage for the residence is secured by the residence itself. That would make it deductible as a personal itemized deduction on schedule A.
Will not the tracing rules come into play once the home is bought?
https://roundtablewealth.com/resources/mortgage-interest-tracing-rules/
The interest tracing rules apply to the investment property, not the personal residence. Here, the taxpayer is using a mortgage on investment property to purchase a personal residence. The interest tracing rules would determine how much of the interest is deductible as an investment expense on schedule E. The ability to deduct mortgage interest on a personal residence on schedule A is determined by a different section of the regulations, and those regulations are very clear that the mortgage must be secured by the residence. If I borrow money to buy, build, or improve my home through a personal loan or credit cards or a loan from my 401(k), that interest is never tax deductible home mortgage interest because the loan is not secured by the residence, even if it is fully traceable.
Remember, this taxpayer is turning the usual question upside down. The question we usually see is something like, “I want to take out a home equity loan from my paid up house to buy a second house to use as a rental.“ In that case, HELOC interest on the primary residence is no longer deductible on schedule A after the tax reform of 2018, but the interest might be deductible as an investment expense if it is traceable.
In this case, the taxpayer wants to borrow off the investment property to buy a personal residence. The traceability rule applies to the business property but not to the personal residence.