Income Tracing on Cash out Refi

3 Replies

I'm currently in the process of doing a cash out refi on my primary, and plan to use the proceeds to purchase more rentals. I am planning on counting the loan as a loan not secured by my home per IRS publication 936. My question is:

Do I have to treat the amount put towards the initial escrow balance as a personal expenditure once taxes and insurance are paid? Or can I just discount that amount of the loan as part of the loan expenses and call the proceeds the check I get?

@Ben Parr

 Are you saying you want to pull capital out of one property and call it a expense for another property?


Frank

@Frank Romine

I am doing a cash out refi on my primary residence and counting the loan as not secured by my home as described in IRS publication 936. 

Then, I will be placing the proceeds of the loan in a separate account while I deploy the cash into new investments over time (per the IRS income tracing rules). This allows me to claim the interest expense from the loan as an investment expense or passive income expense depending on the final usage.

My loan however, is set up with an escrow for taxes and insurance so when I get the loan I'll get a check, and I'll get a pre-funded escrow account for taxes and insurance.

As the usage of those escrow account funds will be for my primary residence, it would seem to be considered a personal use of funds and therefore, to the extent of the use of those funds, I would not be able to write off the interest attributable to that portion of the loan proceeds. For a round number example I'm getting 99k in a check, and 1k in an escrow account. Once the first $1,000 is paid out of that account (for taxes) I will not be able to write off 1% of my loan interest. 

It's actually a bit more involved than that, but that's the gist. My question is, can I count that $1,000 as an expense of the loan and say my loan proceeds were only $99,000, or do I need to include the $1,000 as part of my loan proceeds.

Only the amount of a loan attributed to the price of the investment property will be an interest expense for that property, interest on loan proceeds to pay taxes and insurance on a business property are a business expense. Taxes and insurance on a primary home are not a business expense nor are they deductible except as to taxes paid on a personal return. Closing costs of a business property are amortized not expensed off .

Since you are refinancing your personal home, I'd show up with escrowed funds and not take the money out of the loan proceeds, that is comingling funds.

It would be much cleaner if you got the loan in the LLC name, assigned the collateral and signed personally with your guarantee, the loan would then be to the LLC.

I'm not the Tax Guy here, @Steven Hamilton II   is :)

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