USA Refinance of primary residence to pay off rental properties.

[PaulSD]

Hello. I am thinking of a cash out refinance of my primary residence to pay off a couple rental property mortgages with higher rates. Would I still be able to deduct the interest of those portions of the new loan, in my rental properties expenses, even though the loan is now associated with my residence? How would this be done in practice? Is there some kind of depreciation schedule, for lack of a better term, that could keep track of the interest and principal of that portion of the loan each year? Thanks, Paul

 

[kirby]

To use the mortgage interest deduction from a refi you'd have to use the funds on your OWN home, to substantially improve it - like a room addition, for example.

So, sorry, no, you can't get an itemized interest deduction for what you described.

 

[PaulSD]

Thanks for the reply Kirby! I think you may have misunderstand that I want to take the deduction from the rental property expenses, just as if I had just refinance those loans separately. Not itemized deductions on my primary residence. I read elsewhere you can but they gave no details about how to actually keep track of it. It is debt replacing acquisition debt of those rental properties so it seems only fair that it shouldn't matter how the money is secured. Of course I may be wrong and what I read is wrong. That's the internet for you and I am not an accountant.

 

[Werner Reisacher]

Kirby cautioned me not to take internet info without double-checking very recently. So, you double-checked and Kirby told you the facts. He is absolutely correct.
You must have gotten your info from Financial Adviser's website promoting investments/option deals, financed by tax-deductible margin loans. But such deals are a different ball game. They carry twice the risk of gambling in a Casino since you risk not only lose the money you invested, you still have to repay the funds borrowed.
Considering the present level of interest rates, a much simpler approach to lower your overall interest payments would be to renegotiate all three mortgages - all three tax-deductible.

 

[PaulSD]

Kirby cautioned me not to take internet info without double-checking very recently. So, you double-checked and Kirby told you the facts. He is absolutely correct.
You must have gotten your info from Financial Adviser's website promoting investments/option deals, financed by tax-deductible margin loans. But such deals are a different ball game. They carry twice the risk of gambling in a Casino since you risk not only lose the money you invested, you still have to repay the funds borrowed.
Considering the present level of interest rates, a much simpler approach to lower your overall interest payments would be to renegotiate all three mortgages - all three tax-deductible.

Thanks Werner. I really do appreciate every response. I am not planning to do any investment scheme or anything, no casino games. Simply get a lower rate on my investment property loans. Investment property loans always carry higher rates than your primary residence, plus some of my loans with the highest rates are too small to refinance, as they won't refinance loans less than a certain amount. I have three properties with a total of around 240k left in principal. I have looked into trying to combine them to no avail. I would just refinance my primary residence with 200k cash out, at 3.25%, and try to pay off the remainder myself as income permits. My rental property rates are 4.625% approx average. I have not found a way to do much better on them individually. Do you have any link to a document from the IRS or anyone else reputable saying you cannot write off interest in a loan against your primary house for rental property expenses after rolling those funds in? I already have been writing off some of the interest of my HELOC that I used to pay down one of these properties, so perhaps I am already heading to IRS prison

 

[kirby]

Hi PaulSD
Here is your cite:
IRS Publication 936

Download that and right near the top it says this:

Interest on home equity loans and lines of credit are deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan. As under prior law, the loan must be secured by the taxpayer’s main home or second home (qualified residence), not exceed the cost of the home, and meet other requirements.

Later on it covers refinanced debt and the basic rules above still apply.

 

[PaulSD]

Thanks Kirby. That publication is for the home interest deduction in itemized deductions, not rental property business expenses. The proper publication to reference is publication 535, I believe. For instance, in chapter 4 it states the following:

"Interest You Can Deduct
Your trade or business interest expense may be limited. See the Instructions for Form 8990 for more information. Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. It does not matter what type of property secures the loan."

It is a long document and I am trying to dig through it, but the last part above seems pretty clear to me. Please tell me if you think I am wrong. My 5 rental properties qualify as a business and business expenses are different than itemized deductions.

 

[kirby]

Asked and answered. I don’t think I can do anything more here.
Good luck.

 

[PaulSD]

Thanks for your help Kirby.

 

[Werner Reisacher]

The issue is not whether you can or cannot deduct interest charges on your rental property.
You can turn this issue any way you want, the questions from the IRS remains the same. How do you explain why tax-deductible interest on your mortgage has increased and at the same time, your rental properties do no longer show interest expenses?
Even if you use funds that you already had in other investments and use them to repay the loans. You cannot use personal funds and lend it to the "your properties" without showing interest expense on your Schedule E and interest income on your Schedule 1040 to eliminate the expenses. Remember, the transfer of economic value always generates an economic benefit for the receiving party. In order for interest expenses to be tax deductible, somebody else has to show a taxable income.
The IRS has a very sophisticated computerized auditing system in place. They have all the details of your mortgages in their records. The above-mentioned changes on your tax reports would most certainly trigger the red flag.

 

[PaulSD]

Thanks for the reply Werner. When you take a cash out refi on your primary residence, you only declare the interest on the part that was the amount refinanced. The taxable interest on schedule A does not increase. I have done this before with my Heloc. The form allows you to enter only the interest for acquisition or improvement of your primary residence. The amount of interest for the rental property is a seperate form on schedule D for the rental property. In turbotax they ask if you paid any other interest for the property. I am kind of confused why there is not more info about this subject because it seems clear to me, but I do my own taxes and I am just an engineer.

 

[Werner Reisacher]

Great Paul. I learned more from Engineers in my life than from Accountants. It's a thing called "logics and analytical thinking".
Accountants are focused on balancing. Engineers focusing on twisting it around until it works.
Let me try it another way around.
Let's assume that you have a wife and for tax purposes, you file a joint tax return. But from a financial and legal point of view, you keep your personal finances strictly separate from each other. You own the primary residence, she owns the rental properties. Your interest expenses have increased but you will not claim the additional interest on your Schedule A for reasons we discussed.
You have $ 200 K in your pocket. Your wife, the owner of rental properties proposes to you lend her money.
Now you are the Bank. You are lending her money as a loan, and she pays interest to you. Comes tax time, you have to report a taxable interest income on your 1040. She, in turn, repays the mortgages on her rentals and claims the interest expenses she pays to you as tax-deductible interests on Schedule D. (her rentals)
Comes tax time, you consolidate your financial positions with hers. You have to report your interest income on Schedule B and she will claim her interest paid on Schedules D (her rental properties) Since you file MFJ you are back at square one. Yes, interest paid for investments is tax deductible but the one who receives the interest has a taxable income.

 

[PaulSD]

Thanks Werner, so I think I get your point now. I would be lending my personal money (the cash out) to the business so that interest would be taxable cancelling out (or worse) the business deduction. I wonder if this type of scenario is documented anywhere in the IRS forms instructions. That is the thing to me that is frustrating about taxes. Seems like so much is up to interpretation. I like equations and physics where you can prove things wrong. So many times I have googled tax topics and seen different answers. Anyway the point is probably moot since I just found today out my company cut everyones salary 50% so I am not sure how that affects my ability to refinance, plus I don't want the cash out of pocket for closing costs. Is there any other way to take advantage of the fact that I have multiple properties with a ton of equity, to somehow refinance more affordably? I talk to lenders but things always go back to the old fashioned refi each house seperately. I also never did any special business docs, just file as sole proprietor. I realize liability benefits for certain business arrangements but never saw a huge financial benefit that made it worth my time, but maybe I should look into it. I file my taxes as they were getting too expensive, and I have to file so many forms and 3 states for example. Perhaps I am missing out on savings I don't know about and maybe I will get in trouble. For example I paid down one property from funds from my HELOC and have been writing off that interest, so I may end up in IRS prison