Hello, my main residence is in Washington State and I own a rental property in Arizona. I’m considering a cash out refinance on my rental property in AZ: will all interests be tax deductible regardless of where I spend the money from the cash out (since it is an investment property)?
If not, would money spent to improve my main residence qualify for interest deduction?
The refi is secured by the rental property itself. 100% of it. So the interest paid on the loan is 100% deductible as a rental business expense. This is not to be confused with a HELOC, where it DOES matter what you do with the money.
i believe interest tracing rules apply to the interest on the cash-out portion of your refinance. If the cash-out money was used to buy a new rental property, the interest is a rental expense for the new property and not for the property you refinanced. If the cash-out money was used to improve your primary residence, then the interest would be a Schedule A deduction for home mortgage interest, but only if you itemize. If the cash-out money was used for some personal purchase (vacation, new car, pay off credi cards, etc) or just put in the bank to collect interest, then the loan interest on that money is a personal expense and not deductible. The portion of the new loan that refinanced the original acquisition debt on the refinanced property is still an interest expense for that property. Does not matter whether the loan is a cash-out refinance or a home-equity loan.
Just how I see it. Consult your own tax professional for specific guidance appropriate to your circumstances.
If the cash out portion of the cash out refinance is used for primary home improvement, I am pretty sure the interest of that portion is not deductible as expense of that rental (regardless of the fact that the loan is secured by the rental)
I did a cash out refinance on rental A and used it as a down payment of my rental B. The interest of the cash out portion of rental A is reported as an expense of my rental B instead of rental A. So in my case, it is still true that 100% deductible as rental business expense, but reporting on a different rental. I think the second answer is more accurate than this one.
Note. 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.
if you borrow against one home and use the proceeds against another home, it's not tax-deductible. Example: I own my home free and clear. I borrow against it to buy a vacation home. The interest is not tax deductible because I did not use the funds to buy, build or improve the home that secures the loan.
The example here seems to say otherwise:
You secure a loan with property used in your business. You use the loan proceeds to buy an automobile for personal use. You must allocate interest expense on the loan to personal use (purchase of the automobile) even though the loan is secured by business property.
https://www.irs.gov/pub/irs-pdf/p535.pdf , page 14
MY CPA is telling me that the interest is 100% deductible, because it is a loan that must be repaid AND it is a loan against an investment (business) property. I believe that doing a cash-out on a re-fi is considerably different from doing same on a residence. From what I read on the net, however, this issue seems less than 100% clear...
You may want to review Chapter 4 of Publication 535: https://www.irs.gov/pub/irs-pdf/p535.pdf
It is very clear that the interest has to be allocated, and may be deductible or nondeductible, based on the use of the funds.
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To DaveT1315, The unclear area for me is whether the funds from the Cash-Out refi of rental property that was use to purchase or improve a primary residence is tax deductible on schedule A for the primary residence? I thought that the tax law says that inorder for the mortgage interests to be tax deductible on Schedule A, it has to be secured against the property that is your primary residence?