Are loan payments tax deductible when pulling STR equity out?

Question

Hi everyone, long-time listener, first-time caller... I am in awe of all your collective knowledge and hoping to tap into it for something I've been curious about.

I own a STR with no mortgage, held directly not in an LLC and I deduct on Schedule E for Federal tax purposes. Because of depreciation I generate a paper loss every year. I cannot deduct that loss due to my income level.

I would like to pull equity out of this property with no immediate plans on the table to use it, but want it available for possible use for another property. My question is, is the interest, closing costs, etc. a deductible expense for the property on Schedule E?

If not, how does everyone pull equity out of their properties to use for other purposes?

Thanks in advance for all your help!

Joe

Mark Miles · Answer

LOLOLOLOL!!! I cannot say this enough times: sell your properties in the north and buy properties down south!!!

“It is a seasonal rental condo in New Jersey, which has a limited summer rental season, high property taxes and HOA expenses.”

Let me say this as nicely as possible for the 1000th time: you can only invest every dollar once, invest it where you will make the highest ROI. Plain and simple, period.

Luke Carl · Answer

Ask a CPA. But before you do that. Ask that CPA how many rental properties they own.

BUT BEFORE THAT I WOULD....

Sell that thing and 1031 into a bunch of down payments on properties that actually make money.

Tim Schroeder · Answer

Ditto.

Chris Gottshall · Answer

The #1 reply to this will be: Consult with your CPA regarding your situation.

But, in my situation, yes, the *interest* on the loan is a deductible expense on my schedule E before and after refinancing.

John Underwood · Answer

And this advise is coming from a guy who lives up north!

Chris Gottshall · Answer

My understanding is that as long as the cash out is going back into the business, it is deductible. And "the business" doesn't mean only the property you got the equity out of - it means your rental property business, so you could use the cash out for a down payment on another property, because they are all part of your rental property business. Even if the properties are titled to separate LLCs, they all collapse onto your personal return from the IRS's perspective so it is all one rental property business.

That's my understanding; but I am NOT a CPA and not giving tax advice (just to be clear) ;-) I'd be happy to recommend my CPA for a deeper conversation!

Dave Foster · Answer

@Joe Celentano, Your 1031 source is correct but you have to understand their interpretation of equity.  In order to defer all tax in a 1031 you must do two things:

1 Purchase at least as much as your net sale (contract price minus closing costs).

2. Use all of the net proceeds (net sale minus mortgage pay off) from the sale in the purchase of your replacememts.

Any amount you purchase less than your net sale or any amount of cash you take out is considered to first be a dollar of profit by the IRS.  So if you reduce equity by refinancing a property immediately prior to sale you are still left with the  requirement to purchase at least as much as your net sale.

Secondly, what that QI didn't tell you but should have is that a cash out refinance followed closely by a sale and 1031 is looked at suspiciously by the IRS.  There have been many interpretations where this practice was declared a way to access profit but still perform the 1031 to achieve tax deferral.  In other words they're on to this game.  If you want to take any money out you'll need to pay tax on it.

Unless.... You sell and do a 1031 and then refinance after.  That is perfectly fine.  Or you take cash out and pay the tax on it but shelter the rest of the tax in the sale.

Nancy Bachety · Answer

@Joe Celentano 1) wrong. 1031 does not use equity in the home being sold, it uses its sale price. 2) do it.

Dave Foster · Answer

@Joe Celentano, You may be getting a lot of personal use/satisfaction from owning that property.  And that's a whole different issue.  There are really two reasons to hold on to a property that loses money - You're in love with it.  Or it's going to appreciate like gang busters.  So if this property doesn't fit either of those two spots it's a dog that won't hunt.  And adding debt on top of that isn't going to improve the performance.  Even the blended return from a good property bought with the refi is going to be dragged down by the performance of this one.

I don't see this as so much a tax issue as a performance issue.

Joe C. · Answer

It is a seasonal rental condo in New Jersey, which has a limited summer rental season, high property taxes and HOA expenses. I'm debating whether to pull money out and keep it or do a 1031, hence my question.

Are loan payments tax deductible when pulling STR equity out?

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