Tax deductions after refinaning a rental property
Most Popular Reply
Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
1yHi Rick,
First of all- congrats on diving in and your BRRRR deal going well!
Loan interest is deductible based on it's use-not the asset securing it.
Since the HELOC was used for a business use (renovating the rental) you can deduct the loan interest against that rental using the interest tracing rules found in §1.163-10T.
The funds should be cleanly traced ideally. Meaning they went into a standalone bank account (not mixed with your other personal funds).
When you refinance unfortunately all of the interest on that new loan will not be deductible. Again- loan deductibility is based on the use of funds, not the asset. So just because it's a loan on a rental property doesn't necessarily mean the interest will be deductible.
There are types of deductible debt:
- Acquisition debt (a loan to directly acquire an asset)
-Renovation loan (loan against an asset, used to renovate that asset)
-Replacement debt (a loan which is a refinanced replacement of an initial qualifying replacement).
When you refinance- $70k of your new loan will qualify as replacement debt. (replacing the original HELOC debt)
However whether the interest for the additional $200kish of loan will be deductible will depend on 2 things:
-How were the renovations paid for? If those were also initially funded with debt like a HELOC, then it would also qualify as replacement debt.
- If you just personally paid for the renovations then the interest won't be deductible because "paying yourself back" doesn't qualify.
And then there's any cash-out component.
So if yo had $70k of initial purchase debt, for example spent $100k on renovations- and now you get a loan for $200k....$100k can potentially be deducted as replacement debt.
But that extra $100k beyond that....depends on what you used those funds for.
If you used them to purchase another rental/ use for another business endeavor...the process starts over. You can trace the interest to that business use.
If you use the extra $100k of cash you receive to just...live on, buy a jetski, take a trip to Disney, (any personal use) the interest for that portion of the loan will not be deductible.
Things like this are why it's important to work with a professional who is well versed in real estate taxation because the "common/simple" strategies taught frequently like BRRR or house hacking actually get fairly complicated when it comes to handling it correctly.
7 Replies
- 1yMia TaylorPro MemberMember since 2024 · 11 posts · 2 votes
Hi Rick,
Yes you can deduct the HELOC mortgage expense for your rental only...not for your personal residence. The reason the answer is framed this way is because when you take a HELOC out to make repairs on your personal residence, you are allowed to tax the interest deduction on your Schedule A of your 1040 income tax return. However, because the HELOC's intent is for the rental property you own...you are allowed to take the mortgage interest on your Schedule E.
To your second question, the answer is Yes. You should receive a 1098 form from your mortgage provider.
Mia
- Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes1y
Hi Rick,
First of all- congrats on diving in and your BRRRR deal going well!
Loan interest is deductible based on it's use-not the asset securing it.
Since the HELOC was used for a business use (renovating the rental) you can deduct the loan interest against that rental using the interest tracing rules found in §1.163-10T.
The funds should be cleanly traced ideally. Meaning they went into a standalone bank account (not mixed with your other personal funds).
When you refinance unfortunately all of the interest on that new loan will not be deductible. Again- loan deductibility is based on the use of funds, not the asset. So just because it's a loan on a rental property doesn't necessarily mean the interest will be deductible.
There are types of deductible debt:
- Acquisition debt (a loan to directly acquire an asset)-Renovation loan (loan against an asset, used to renovate that asset)
-Replacement debt (a loan which is a refinanced replacement of an initial qualifying replacement).
When you refinance- $70k of your new loan will qualify as replacement debt. (replacing the original HELOC debt)
However whether the interest for the additional $200kish of loan will be deductible will depend on 2 things:
-How were the renovations paid for? If those were also initially funded with debt like a HELOC, then it would also qualify as replacement debt.
- If you just personally paid for the renovations then the interest won't be deductible because "paying yourself back" doesn't qualify.
And then there's any cash-out component.
So if yo had $70k of initial purchase debt, for example spent $100k on renovations- and now you get a loan for $200k....$100k can potentially be deducted as replacement debt.
But that extra $100k beyond that....depends on what you used those funds for.
If you used them to purchase another rental/ use for another business endeavor...the process starts over. You can trace the interest to that business use.
If you use the extra $100k of cash you receive to just...live on, buy a jetski, take a trip to Disney, (any personal use) the interest for that portion of the loan will not be deductible.
Things like this are why it's important to work with a professional who is well versed in real estate taxation because the "common/simple" strategies taught frequently like BRRR or house hacking actually get fairly complicated when it comes to handling it correctly. - 1yRick ImMember since 2023 · 24 posts · 11 votesOP
Quote from @Natalie Kolodij:
Hi Rick,
First of all- congrats on diving in and your BRRRR deal going well!
Loan interest is deductible based on it's use-not the asset securing it.
Since the HELOC was used for a business use (renovating the rental) you can deduct the loan interest against that rental using the interest tracing rules found in §1.163-10T.
The funds should be cleanly traced ideally. Meaning they went into a standalone bank account (not mixed with your other personal funds).
When you refinance unfortunately all of the interest on that new loan will not be deductible. Again- loan deductibility is based on the use of funds, not the asset. So just because it's a loan on a rental property doesn't necessarily mean the interest will be deductible.
There are types of deductible debt:
- Acquisition debt (a loan to directly acquire an asset)-Renovation loan (loan against an asset, used to renovate that asset)
-Replacement debt (a loan which is a refinanced replacement of an initial qualifying replacement).
When you refinance- $70k of your new loan will qualify as replacement debt. (replacing the original HELOC debt)
However whether the interest for the additional $200kish of loan will be deductible will depend on 2 things:
-How were the renovations paid for? If those were also initially funded with debt like a HELOC, then it would also qualify as replacement debt.
- If you just personally paid for the renovations then the interest won't be deductible because "paying yourself back" doesn't qualify.
And then there's any cash-out component.
So if yo had $70k of initial purchase debt, for example spent $100k on renovations- and now you get a loan for $200k....$100k can potentially be deducted as replacement debt.
But that extra $100k beyond that....depends on what you used those funds for.
If you used them to purchase another rental/ use for another business endeavor...the process starts over. You can trace the interest to that business use.
If you use the extra $100k of cash you receive to just...live on, buy a jetski, take a trip to Disney, (any personal use) the interest for that portion of the loan will not be deductible.
Things like this are why it's important to work with a professional who is well versed in real estate taxation because the "common/simple" strategies taught frequently like BRRR or house hacking actually get fairly complicated when it comes to handling it correctly.Thanks for your insightful response! Just to clarify, I purchased this rental property with 100% financing—$209K from a conventional 75% LTV loan and $70K from my HELOC. While I did spend about $15K on renovations, that amount doesn't need to be factored in for this discussion. If I refinance for $279K, my understanding is that the entire amount would be considered replacement debt. This mean the interest on the full $279K would be fully deductible, right?
Rick - Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes1y
Quote from @Rick Im:
Quote from @Natalie Kolodij:
Hi Rick,
First of all- congrats on diving in and your BRRRR deal going well!
Loan interest is deductible based on it's use-not the asset securing it.
Since the HELOC was used for a business use (renovating the rental) you can deduct the loan interest against that rental using the interest tracing rules found in §1.163-10T.
The funds should be cleanly traced ideally. Meaning they went into a standalone bank account (not mixed with your other personal funds).
When you refinance unfortunately all of the interest on that new loan will not be deductible. Again- loan deductibility is based on the use of funds, not the asset. So just because it's a loan on a rental property doesn't necessarily mean the interest will be deductible.
There are types of deductible debt:
- Acquisition debt (a loan to directly acquire an asset)-Renovation loan (loan against an asset, used to renovate that asset)
-Replacement debt (a loan which is a refinanced replacement of an initial qualifying replacement).
When you refinance- $70k of your new loan will qualify as replacement debt. (replacing the original HELOC debt)
However whether the interest for the additional $200kish of loan will be deductible will depend on 2 things:
-How were the renovations paid for? If those were also initially funded with debt like a HELOC, then it would also qualify as replacement debt.
- If you just personally paid for the renovations then the interest won't be deductible because "paying yourself back" doesn't qualify.
And then there's any cash-out component.
So if yo had $70k of initial purchase debt, for example spent $100k on renovations- and now you get a loan for $200k....$100k can potentially be deducted as replacement debt.
But that extra $100k beyond that....depends on what you used those funds for.
If you used them to purchase another rental/ use for another business endeavor...the process starts over. You can trace the interest to that business use.
If you use the extra $100k of cash you receive to just...live on, buy a jetski, take a trip to Disney, (any personal use) the interest for that portion of the loan will not be deductible.
Things like this are why it's important to work with a professional who is well versed in real estate taxation because the "common/simple" strategies taught frequently like BRRR or house hacking actually get fairly complicated when it comes to handling it correctly.Thanks for your insightful response! Just to clarify, I purchased this rental property with 100% financing—$209K from a conventional 75% LTV loan and $70K from my HELOC. While I did spend about $15K on renovations, that amount doesn't need to be factored in for this discussion. If I refinance for $279K, my understanding is that the entire amount would be considered replacement debt. This mean the interest on the full $279K would be fully deductible, right?
RickHi Rick,
Correct! If it was fully financed on the original purchase it would qualify as replacement debt and be deductible. - 1yBasit SiddiqiBusiness MemberAccountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
You have to follow the interest tracing rules to determine the deductibility of interest.
Basit Siddiqi CPA4.979 Reviews - Durham, NC · Member since 2013 · 502 posts · 215 votes1y
@Basit Siddiqi
Can you elaborate on what that means?
- Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes1y
Quote from @Andreas W.:
@Basit Siddiqi
Can you elaborate on what that means?
I have a detailed reply above that explains it and provides the code citation to read as well
Join the conversationCreate a free account to reply, vote on answers and follow this thread.