Cash out refinance: can I still deduct the full interest of loan?

Question

Let's say I cash out refinance a rental property; can I still deduct the full amount of interest expense on the new loan, or just a portion of it if I don't reinvest the money cashed out? Please post your source.

Ashish Acharya · Answer

@Jack B.

Three scenarios:

1) If you reinvest- yes it is traced to that activity and deducted

2) if you use it for personal use - non-deductible

3) if you hold on to it on your LLC account/ books, but dont reinvest - it can be argued that you are holding on to that money for future repairs and stuff and you refinanced/mortgaged because the interest rate was super low compared to what coming in the future. You have to document your intent to defend your position.

Natalie Kolodij · Answer

https://www.irs.gov/newsroom/interest-on-home-equity-loans-often-still-deductible-under-new-law

Natalie Kolodij · Answer

@Ashish Acharya

IRS Interest tracing rules allow you to deduct business interest related to the manor it was used, not where it was originated.

This was in existence prior to the HELOC rules- and should have been applied prior as well.

If you took a HELOC on your primary to use to buy a rental, that interest should have been deducted on the schedule E for the rental.

This still holds true.

https://www.law.cornell.edu/cfr/text/26/1.163-8T

Pete Alex · Answer

A lot of helpful advise here - thank you all!

I'd like to pose a slight variation on the original question.  Here is the situation:

1) House A is my primary residence, with $200K mortgage.

2) House B a rental with no mortgage (fully owned) and a market value at about $350K

3) Plan: Get a 15-year mortgage on rental House B and take out $200K cash out to pay off the primary residence mortgage.

Question: Would interest on the new 15 year mortgage be deductible against income generated by House B?

Kathy Brown · Answer

I have the same question Pete Alex. From reading through the thread, it seems that the answer is no. That's not the answer I was looking/hoping to see but it makes sense since what I was contemplating doing was moving interest payments from my home (not deductable since I don't itemize anymore) to a rental where it is deductible. I hope some of the experts here will point us in the right direction.

Jack B. · Answer

I take it if it was a primary residence, it would still be entirely fully deductible mortgage interest when you put it back into service, yes?

I'm considering doing this for a few single family rentals I own but also what is once again my primary residence (was when I bought it, then rented it out for a few years, then moved back in). I'm trying to pool more cash for a down turn. Plus some of these rentals have seasoned long enough that even with all of the deductions they are starting to show significant profits from rents alone. Most have doubled or tripled in value since I bought so I want to tap the cash and wait.

Bryan Joyner · Answer

I am considering buying a Dollar General store.  I want to pay cash for it to simplify the closing process, and then come behind within say 90 days to put a commercial mortgage on it.  Will the interest be deductible regardless of what I use the loan proceeds for, or do I have to reinvest the cash out proceeds in real estate?  Premise being here whether the quick refi immediately after the purchase can allow the loan to be treated as an acquisition loan, rather than a cash out refi.  If it must be treated as cash out refi, can investing in stocks/bonds allow the interest to be deducted?   Many thanks for any replies!!

Ashish Acharya · Answer

No it will not be. You got the loan for personal use. The interest accrued can be itemized in your 1040 If your primary residence was used as a collateral.

You are basically taking out a loan for personal use, just as you would spend money out of the credit card to buy a food.

If you use the new rental mortgage for an investment or a business purpose, then yes it could be deductible.

Ashish Acharya · Answer

@Daniel Dietz,

Ignoring the internet deduction issue, would make sense financially for you ?

Are the internet on the house you are going to pay off with new refi loans more than what you are going to get with new refi ?

You need to factor in  loan fees and such as well.

Daniel Dietz · Answer

To all you professionals who contribute bits of advice here, thank you for your time!

Question..... say I do a refi on a rental and pull say 400K out. Let's assume I feel that property can handle the extra debt load etc.... I then take that 400K and pay off (or just pay down) 4 separate properties that each had a 100K balance on them. So 'rental to rental' so to speak.

Obviously the cash flow would go up on the four now paid off units, so that would likely have it's own tax situation change.

Is that 400K that was taken as 'cash out' on the original property still deductable since being used in the rental business?

Thanks, Dan Dietz

Cash out refinance: can I still deduct the full interest of loan?

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