this is tricky
in effect , you did a cashout refi against your primary residence.
the rule is that only 'acquisition' debt is deductible against your primary home. acquisition debt would be the REMAINING mortgage balance you paid to buy the home plus cashout where the money was used to improve your home
So the interest related to the cash out portion of the mortgage is NOT deductible on Schedule A as an itemized deduction,
However, for as long as you own the rental, the interest related to the cash portion of the mortgage is deductible ONLY on schedule E.
Example:
when I bought my home, I took out a $200,000 mortgage.
years later, when the balance was $150,000, I did a cash out refi of $250,000 and used that extra $100,000 to pay off the mortgage on my rental property.
$150,000 is my acquisition debt
my interest rate is 4%
therefore, the interest I can deduct as an itemized expense on Schedule A is $6,000 ($150,000 * 4%)
the rest is deductible on Schedule E as part of the rental expense.
Next year the mortgage balance is down to $240,000. I still can only deduct $6,000 as an itemized expense because the IRS assumes the part that is NOT acquisition debt is paid off first.
Lastly, when the mortgage balance is $200,000, I sell the rental property and pocket the money. I dot pay down the mortgage with the proceeds. When I do my taxes, again, the $6,000 of interest is tax deductible, but the interest related to the remaining $50,000 is no longer tax deductible as it was not used to improve my primary residence.
