Tracing funds from a Cash Out refi

[Claude Niceman]

See example below

Buy property 1mil 250k down 750k loan (ignore CC). NOI 80k, int exp 45k, post finance NOI 35k less depreciation 31k, taxable income 4k

Fast forward 7 years value is up 250k, income up, etc....do a 250k cash out refi.....

What is the status of the extra 15k interest (is it deductible?) the 250k, do I need to invest in something else or can I used it for personal use?

I was told recently by a CPA that if I don't use the 250k to invest in something else or improve the property, the 15k of additional interest is NOT deductible against the 24k of income in year 7 for tax purposes and that the IRS will expect me to trace how the 250k funds are used so I can determine what percentage of the 15k is deductible.

1) Is that accurate? 

2) Is there any legal strategy around that (other than buying another property or improving that property)?

[Curt Riffel]

Interest Tracing rules. Your accountant hits the nail on the head.