Cash-Out Refinance on Primary Resident to buy Rental Property

[dmazz]

I received a Cash Out loan in 2023 on my primary home. Proceeds were used to pay off the small remaining balance of the current mortgage and several home improvements on the primary home; however, the majority of the loan proceeds were used to buy rental property.

Can the 1098 loan interest paid in 2023 be treated as rental expense or should it be considered a regular interest tax deduction?   

[Vanessa A]

Yes, you can include part of the mortgage interest on your primary home as a rental expense.  But only the part that was used to purchase the rental property.  You cannot include the part that was used for anything else. 

On the flip side, you would be able to prorate the mortgage interest and deduct the amount that was used to buy, build or substantially improve the home in which it is secured by.  This means, if the home improvements were buying a lawnmower to cut your grass, that would not be deductible. If you added a deck, that would be deductible.

Ex. If the loan is for $100,000 and $75,000 was used to buy the rental property, $15,000 was used to pay off the old mortgage, $6,000 was used to put on a new deck and $4,000 was used to buy paint and a lawnmower and tools, you would only be able to deduct 21% of the mortgage interest as an expense.  As this would be the only amount that was used to buy, build or substantially improve.  So if your mortgage interest for the year was $5,000 you would be able to include $1,050 as an itemized mortgage interest expense. 

Itemized expenses include mortgage interest, state and local taxes up to $10,000, medical expenses in excess of 7.5% of your AGI and casualty and losses in excess of 10% of you AGI with the first $100 not counting towards the loss.  Your health insurance and all medical expenses are only deductible for the amount that is over 7.5% of your AGI.  This means if your AGI is $50,000, then the amount that is over $3,750 is deductible.  

Then your total itemized expenses would need to be greater than your standard deduction below in order to benefit from your insurance premium payments. 

The 2023 Standard Deductions are as follows:

• Married Filing Joint (MFJ)              $27,700
• Married Filing Separate (MFS)      $13,850
• Head of Household (HOH)             $20,800 
• Single                                                     $13,850                                

Blind and MFJ or MFS add $1,500

Single or HOH if blind add $1,850

(Edit 2/16/24 @ 8:14PM PST) @dmazz