Mortgage Interest deduction tax treatment on mixed use assets

[Art P.]

Hello all tax professionals on BP, I would like to reach out to the knowledge base to see if any of you have dealt with a similar situation as addressed below and how to properly handle it. Thank you in advance!

Topics that this question touches on: Mortgage Interest deduction (limitations), conversion of primary property to rental, multi-unit mixed use tax implications, and cash-out refinancing.

Hypothetical scenario: I own a duplex that I house hack, I treat one side (side A) as personal (schedule A) and the other side (side B) as rental (schedule E). For simplicity, lets say I purchased the property in 2010 for $200,000 ($140,000 loan remaining at time of refi). I want to cash-out refinance the Duplex for $350,000 and take out $250,000 (leaving $100,000 in equity) to use in purchasing another personal SFR (second home to become primary) priced at $400,000 using remaining funds after paying off previous mortgage in the amount of $110,000 ($250,000 cash-out - $140,000 previous mortgage) as the down payment and later rent out side A. If all this transpires in 2019, the question is how much of the debt service amount in interest can I deduct from the new refinanced amount on both Schedule A and Schedule E and going forward in subsequent years if side A is rented?

Assumptions: 
1) I have lived in side A for more than 14 days or 10% of the days it has been rented out (whichever is greater) allowing me to treat side A as a primary residence for the full year.
2) Total personal debt service is under the new TCJA limits of $750,000, no partial limitation to new refinanced amount.

Research and background:

IRS publication 936 alludes to cash used as part of refinance towards a secondary home purchased under a refinance of the primary residence counts towards the mortgage interest deduction on schedule A. In the case above, I am under the understanding that the refinanced amount on the duplex was used "to buy, build, or substantially improve a qualified home" as part of the SFR purchase.

My understanding is that because the new property is not used to "buy, build, or substantially improve" a new or existing rental, then the additional refinanced amount on the rental side is disallowed.

Based on IRS tax codes and the new TCJA, is my understanding correct on the debt service limitations on the individual properties?

Tax year ended 2019:

Schedule A:
Previous Mortgage Side A - $70,000 (50% of $140,000)
New cash out refinance - $125,000 (50% of Cash-out refi of $250,000, $70,000 old mortgage + $55,000 qualified residence mortgage interest)
SFR - New mortgage of $290,000.
Total deductible debt service interest on - $415,000 ($125,000 + $290,000).

Schedule E:
Previous Mortgage Side B - $70,000 (50% of $140,000)
New cash out refinance - $125,000 (50% of Cash-out refi of $250,000)
Total Deductible debt service interest on - $70,000.

Tax year 2020 when side A is rented:

Schedule A:
SFR Mortgage - $290,000
Grandfathered qualified primary residence cash refinance - $55,000
Total deductible debt service interest on - $345,000

Schedule E:
Duplex Mortgage side A - $70,000 (limited to acquisition debt)
Duplex Mortgage Side B - $70,000
Total deductible debt service interest on - $140,000

If I misunderstood Publications 936 and 527 or if there is other authoritative guidance that addresses any specifics on the scenario above please let me know.

[Ashish Acharya]

Originally posted by @Art P.:

Hello all tax professionals on BP, I would like to reach out to the knowledge base to see if any of you have dealt with a similar situation as addressed below and how to properly handle it. Thank you in advance!

Topics that this question touches on: Mortgage Interest deduction (limitations), conversion of primary property to rental, multi-unit mixed use tax implications, and cash-out refinancing.

Hypothetical scenario: I own a duplex that I house hack, I treat one side (side A) as personal (schedule A) and the other side (side B) as rental (schedule E). For simplicity, lets say I purchased the property in 2010 for $200,000 ($140,000 loan remaining at time of refi). I want to cash-out refinance the Duplex for $350,000 and take out $250,000 (leaving $100,000 in equity) to use in purchasing another personal SFR (second home to become primary) priced at $400,000 using remaining funds after paying off previous mortgage in the amount of $110,000 ($250,000 cash-out - $140,000 previous mortgage) as the down payment and later rent out side A. If all this transpires in 2019, the question is how much of the debt service amount in interest can I deduct from the new refinanced amount on both Schedule A and Schedule E and going forward in subsequent years if side A is rented?

Assumptions: 
1) I have lived in side A for more than 14 days or 10% of the days it has been rented out (whichever is greater) allowing me to treat side A as a primary residence for the full year.
2) Total personal debt service is under the new TCJA limits of $750,000, no partial limitation to new refinanced amount.

Research and background:

IRS publication 936 alludes to cash used as part of refinance towards a secondary home purchased under a refinance of the primary residence counts towards the mortgage interest deduction on schedule A. In the case above, I am under the understanding that the refinanced amount on the duplex was used "to buy, build, or substantially improve a qualified home" as part of the SFR purchase.

My understanding is that because the new property is not used to "buy, build, or substantially improve" a new or existing rental, then the additional refinanced amount on the rental side is disallowed.

Based on IRS tax codes and the new TCJA, is my understanding correct on the debt service limitations on the individual properties?

Tax year ended 2019:

Schedule A:
Previous Mortgage Side A - $70,000 (50% of $140,000)
New cash out refinance - $125,000 (50% of Cash-out refi of $250,000, $70,000 old mortgage + $55,000 qualified residence mortgage interest)
SFR - New mortgage of $290,000.
Total deductible debt service interest on - $415,000 ($125,000 + $290,000).

Schedule E:
Previous Mortgage Side B - $70,000 (50% of $140,000)
New cash out refinance - $125,000 (50% of Cash-out refi of $250,000)
Total Deductible debt service interest on - $70,000.

Tax year 2020 when side A is rented:

Schedule A:
SFR Mortgage - $290,000
Grandfathered qualified primary residence cash refinance - $55,000
Total deductible debt service interest on - $345,000

Schedule E:
Duplex Mortgage side A - $70,000 (limited to acquisition debt)
Duplex Mortgage Side B - $70,000
Total deductible debt service interest on - $140,000

If I misunderstood Publications 936 and 527 or if there is other authoritative guidance that addresses any specifics on the scenario above please let me know.

Dude!!! Feels like a case study. 

1) After refi, interest up to the original amount(140k) is treated the same way as it has always been. 50% A and 50% E

2) The new additional debt (110k) after the refi is deductible at E if the entire amount if the new home is used for rental or Sch A if you treat the new home as a second home, interest training rule.

3) New 290k loan is Schedule A deductions if used as second home or Schedule E deduction if used as Rental.  

Tax year ended 2019:

Schedule A:
Previous Mortgage Side A - $70,000 (50% of $140,000) - Correct
New cash out refinance - $125,000 (50% of Cash-out refi of $250,000(Incorrect), $70,000 old mortgage(from above - correct) + $55,000 qualified residence mortgage interest) (incorrect - full 110k if total is used as down payment for the second home )
SFR - New mortgage of $290,000. - Correct
Total deductible debt service interest on - $415,000 ($125,000 + $290,000). (Incorrect 70+110+290)

Schedule E:
Previous Mortgage Side B - $70,000 (50% of $140,000) -correct
New cash out refinance - $125,000 (50% of Cash-out refi of $250,000) - incorrect - not included in E ( already included the extra 110k above in schdule A) 
Total Deductible debt service interest on - $70,000. - Correct

Reconciliaton 

Total debt = 140+110+290

Scheudle A = 70+110+290

Schedule E = 70

140+110+290 =70+110+290+70

Tax year 2020 when side A is rented:

Schedule A:
SFR Mortgage - $290,000 - correct
Grandfathered qualified primary residence cash refinance - $55,000 - incorrect (110k)
Total deductible debt service interest on - $345,000 (290+110)

Schedule E:
Duplex Mortgage side A - $70,000 (limited to acquisition debt) ( Correct) 
Duplex Mortgage Side B - $70,000 (Correct)
Total deductible debt service interest on - $140,000 (Correct)