Investment Property - Can't Deduct Impacts Nobody Mentions???

[Rocco Swinney]

Hi All!

I started using biggerpockets about a month ago and I see so many folks mention about obtaining a cash-out refinance on their investment properties... I was hoping someone could clarify the below, as my understanding is you CANNOT simply deduct the interest right away. Example Only below:

Ex,. Investment Property worth 200k. You takeout a cash out refinance for 100k. The 100k is not deducible at this time. However, you end up using 50k of it on a down payment for another investment property for 2020. So you can only deduct 50% of the interest from property 1because only 50k of the 100k was used for investment purposes for 2020. There is not a timeframe when you must use the other 50k, correct? Ex. In 2021 you then use the other 50k as a down payment on another investment property so for 2021 you can then deduct 100% interest from the original investment property you obtained the cash out refinance on.

[Kyle J.]

@Rocco Swinney This is my understanding...interest you pay on a cash out refi on a rental property does not automatically become deductible simply because the cash out refi was done on a rental. Interest tracing rules apply.

So, for example, you take $100k out of rental Property A and you use that to purchase rental Property B. Then the interest you’d pay on that money would be a tax-deductible expense against rental Property B.

However, let’s say you take $100k out of the same rental property, but you use the proceeds to buy a new sports car and take your family on vacation. That interest would not be deductible (even though it originally came from a rental property), because it wasn’t used to buy or improve your rental properties.

Now, where it gets a little trickier (and what I think you’re asking about), is what happens if you take out money from a rental property but you don’t actually use some/all of it for a long period of time (a year or more) to buy another rental property. You want to know if the interest would be tax-deductible while it’s just sitting in a bank account in the meantime, correct?

If so, it’s my understanding that if/when you ultimately did purchase another rental property, the interest would then be tax-deductible as an expense against that property. However, for the long period of time the money is just sitting in your bank account, the interest you pay would not be tax-deductible.

Here’s a recent article on BP from a CPA that seems to confirm that last part: 
https://www.biggerpockets.com/blog/tax-traps-tax-opportunities-refinances

(Read the comments section where someone asks “Is there a time limit if the money from the refi is just sitting in a bank account?” And the author responds “No time limit but just keep in mind that when it is sitting in the bank, the interest is not tax deductible in the interim.”)

Perhaps one of the expert CPA’s or accountants on here will chime in if I said anything that isn’t exactly correct (if they do, take their advice over mine because I’m neither a CPA or an accountant).

Ultimately, the best thing to do would probably be to consult with your own tax professional who is familiar with your unique tax and investing situation.