Interest deduction for line of credit

6 Replies

Wondering if someone knows the answer to these tax questions... perhaps @Steven Hamilton II  ?

If you use a line of credit to finance the purchase of a rental property (not a HELOC), I know the interest is tax deductible. My question is, do you have to deduct the interest on Schedule E against the specific property the funds were used to purchase? Or, can you deduct the interest on Schedule A as investment interest?

If both are possible options, what are the pros and cons?  It seems to me that putting it on Schedule A would be preferable as it could potentially offset some interest income from non-rental property investments.  If it goes on the Schedule E and there's already a tax loss from depreciation, then the interest deduction would not result in a lower tax bill, but simply get carried forward to offset future rental income.  Am I thinking about this right?


Thanks

The deduction for investment expense is limited by a 2% of AGI floor. There is no such limitation for Schedule E. You may be able to deduct a rental loss against ordinary income if you qualify for the special allowance. Also, if you look at the instructions for Schedule A, Line 14, it states that investment interest does not include any interest allocable to passive activities. Without reading the regulations, I assume this would not be allowed:

"

Line 14
Investment Interest
Investment interest is interest paid on
money you borrowed that is allocable to
property held for investment. It does not
include any interest allocable to passive
activities or to securities that generate
tax-exempt income."

http://www.irs.gov/pub/irs-pdf/i1040sca.pdf

I would look at IRS publication 550 (Investment Income & Expenses). My thoughts are you intend on keeping the property as a rental and will ultimately report income expenses on schedule E. You cant report some income/expense on schedule E and carve out the interest expense from the line of credit and call it an investment activity and an itemized deduction on schedule A. You have to group the activities together. The only scenario I could see schedule A is if you held onto the house as an asset and portfolio investment and didn't intend on it generating any rental income-- it sat idle for example, no renters, waiting for a quick flip, etc.

Those are my thoughts you might find some other advice or direction on this board from those practicing CPA's that have direct experience.

Originally posted by @Mark D.:

I would look at IRS publication 550 (Investment Income & Expenses). My thoughts are you intend on keeping the property as a rental and will ultimately report income expenses on schedule E. You cant report some income/expense on schedule E and carve out the interest expense from the line of credit and call it an investment activity and an itemized deduction on schedule A. You have to group the activities together. The only scenario I could see schedule A is if you held onto the house as an asset and portfolio investment and didn't intend on it generating any rental income-- it sat idle for example, no renters, waiting for a quick flip, etc.

Those are my thoughts you might find some other advice or direction on this board from those practicing CPA's that have direct experience.

 Publication 550 says the same regarding investment interest:

Investment Interest

If you borrow money to buy property you hold for investment, the interest you pay is investment interest. You can deduct investment interest subject to the limit discussed later. However, you cannot deduct interest you incurred to produce tax-exempt income. See Tax-exempt income under Nondeductible Expenses, later. You also cannot deduct interest expenses on straddles discussed under Interest expense and carrying charges on straddles , later.

Investment interest does not include any qualified home mortgage interest or any interest taken into account in computing income or loss from a passive activity.

Passive activity. A passive activity generally is any activity involving the conduct of any trade or business in which you do not materially participate and any rental activity. However, if you are involved in renting real estate, the activity is not a passive activity if both of the following are true.

  • More than one-half of the personal services you perform during the year in all trades or businesses are performed in real property trades or businesses in which you materially participate.
  • You perform more than 750 hours of services during the year in real property trades or businesses in which you materially participate.

http://www.irs.gov/publications/p550/ch03.html#en_US_2013_publink100010203

Thanks @Wilson Churchill  and Account Closed 

I didn't realize that the instructions for Schedule A, Line 14 state that investment interest does not include any interest allocable to passive activities.  That makes it pretty straightforward.  Schedule E it is.

Btw, I believe interest expense is one investment related expenses that is not subject to the 2% AGI floor.

Originally posted by @Paul C.:

Thanks @Wilson Churchill and Account Closed 

I didn't realize that the instructions for Schedule A, Line 14 state that investment interest does not include any interest allocable to passive activities.  That makes it pretty straightforward.  Schedule E it is.

Btw, I believe interest expense is one investment related expenses that is not subject to the 2% AGI floor.

 You are right. I was looking at investment expenses. Most of the time Schedule E will be better, anyways.

Oh yeah, and the deduction is limited to net investment income:

Limit on Deduction

Generally, your deduction for investment interest expense is limited to your net investment income.

You can carry over the amount of investment interest you could not deduct because of this limit to the next tax year. The interest carried over is treated as investment interest paid or accrued in that next year.

You can carry over disallowed investment interest to the next tax year even if it is more than your taxable income in the year the interest was paid or accrued.

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