Is there a Tax Benefit to having Mortgage interest all on rental property ?

Question

I am in the process of moving to FL where I have 2 short term rentals. both with mortgages on and the new Primary will also have a mortgage. Is there a tax advantage if I do a cash out refinance of one of the rentals and buy the primary out right?

I like the idea of owning our primary outright, but doesn't that Mortgage interest on the primary get deducted anyway?

Thanks in Advance

I like the idea of owning our primary outright, but doesn't that Mortgage interest on the primary get deducted anyway?

Thanks in Advance

David Orr · Answer

Doing a cash-out refinance of a rental property doesn't make the interest on that loan deductible as an expense for the rental, which I think is what you were hoping to do.  There are "interest tracing rules", that can roughly be summarized as the interest on a loan is deductible as a business expense only if you use the funds for that business.  It doesn't really matter that a rental property is securing the loan, what matters is how you use the funds. If you used the funds to renovate the rental property, then the interest would be a deductible expense for the rental property.

Ben's reply has good info on the deductibility of having a mortgage on your primary residence, and how it's only really beneficial if the interest and along with your other itemized deductions is more than your standard deduction.  But tax purposes, just getting a mortgage on your primary is probably still going to be the best option.  It will almost certainly also be at a lower interest rate than doing a cash-out refi of a rental property.

David OrrTax Modern

Ben Zimmerman · Answer

The interest on your primary is sort of deductible. And by that I mean that it is only deductible if you itemize your taxes. If you don't have enough random deductions to warrant itemization and you simply take the federal standard deduction, then your primary interest doesn't do you any good. The standard deduction is currently 14,600, or 29,200 if married filing jointly. And that's just the amount to meet the minimum threshold for itemization, you realistically don't start seeing any benefit until you hit those initial thresholds which is a lot of interest payments. So 30k in interest payments on a primary would only net most people an $800 tax deduction since they would have already got the standard deduction by default, where as 30k in rental interest would translate into 30k in deductions.

This means that for an awful lot of people, they effectively don't get to deduct the interest on their primary.

Keeping the loan on your rentals, while getting rid of the loan on your primary also helps from an asset protection side of things. Many states have homestead style laws that make it difficult to take someone's home during a lawsuit or similar event.

However, cash out refinances are typically at a higher interest rate than a normal mortgage.

Account Closed · Answer

Hey Chad,

Congrats on the real estate success thus far. I was just out in Tampa for a conference last week and am missing the weather already.

You can deduct the mortgage interest you paid during the tax year on the first $750,000 of your mortgage debt for your primary home or a second home. So to answer your question, it depends on the total mortgage you have. After that amount, you cannot deduct any more interest. My personal opinion is owning your home outright is an amazing feeling and impressive feat. I would suggest you do that, even if it doesn't make the more IRR

Jason Watson · Answer

What some people are suggesting above is "equity stripping" where you keep your direct equity small in case of lawsuits or other troubles. I am not a big fan of this unless you can earn good money on the cash you pull out; and it makes things a bit illiquid.

Conversely... paying off a real estate loan feels good, but at the same time getting cash out of a house that is paid for is not necessarily hard but can be a pain.

At times I suggest that people run parallel for a bit... have your cash sitting somewhere earning 5-6% and have your loan charging you 5-6% (or less or more, I know, but...). See how that feels... the net is the same (provided you can deduct the interest against the interest income earned, I get it again, but...). Even if your mortgage is 8% and you earn 6%, the tax-effected 8% becomes a 6% (assuming you can deduct it, again, I get it, but...).

Once things feel good and you are settled, then you knock off that loan with your pile of cash. But this parallel system buys you time. Time adds clarity and keeps you off your therapist's couch.

I also suggest to anyone in real estate to constantly be pushing the line of credit envelope with your lender. I just renewed my personal line of credit on an office building we own, plus I will get another on a rental we have in a bit. Max lines = flexibility. Provided your cashflow can support the limits, have lines on everything you own... whether you use them or not doesn't matter. But you will sleep better.

Jonathan Bock · Answer

From the asset protection perspective having the debt on the rentals and owning your primary in FL has some advantages that many states do not offer wish my home state had this.

Chad R. · Answer

Some great answers, my intent would not be to spend the $$ on the investment property but to pay off the mortgage on the primary. Taking the rental property mortgage form 162k ->362k.

Jorge Vazquez · Answer

With over 20 years in real estate and thousands of deals under my belt, I'd say there's definitely a cozy feeling to owning your primary home outright. But keep in mind, the mortgage interest on that home is tax-deductible, which can save you some cash at tax time. If you're thinking about a cash-out refinance on one of your rentals to buy your primary, that could work too, since the interest might still be deductible if you invest that cash back into your properties. Definitely a good idea to chat with a tax pro who gets the real estate game to make sure you’re set up right.

Is there a Tax Benefit to having Mortgage interest all on rental property ?

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