Cash out refinance - Interest deductibility

4 Replies

Quick question here.  If I do a cash-out refinance and use the extra funds above those used to pay off the original mortgage to purchase a new investment property is interest on the entire new loan deductible?  For example, If I have a property worth $250,000 with an $80,000 mortgage and do a cash-out refinance for $180,000, pay off the $80,000 and use the extra $100,000 to buy a new investment property (down payment) can I deduct the entire interest on the new loan of $180,000.  My understanding is that GENERALLY (I think there are other situations) I am only allowed to deduct interest if the proceeds are used to make improvements on the original property and cannot deduct the entire amount until the improvement are actually made.   I think this may be a timely topic given where rates are.  I would greatly appreciate any feedback and references to the tax code on this.  Also, not sure if any recent changes in the tax code affected this as well.

Originally posted by @David V. :

Quick question here.  If I do a cash-out refinance and use the extra funds above those used to pay off the original mortgage to purchase a new investment property is interest on the entire new loan deductible?  For example, If I have a property worth $250,000 with an $80,000 mortgage and do a cash-out refinance for $180,000, pay off the $80,000 and use the extra $100,000 to buy a new investment property (down payment) can I deduct the entire interest on the new loan of $180,000.  My understanding is that GENERALLY (I think there are other situations) I am only allowed to deduct interest if the proceeds are used to make improvements on the original property and cannot deduct the entire amount until the improvement are actually made.   I think this may be a timely topic given where rates are.  I would greatly appreciate any feedback and references to the tax code on this.  Also, not sure if any recent changes in the tax code affected this as well.

Whether it is deductible follows use per IRS tracing rules. If property 1 is a rental property, then the interest on $80,000 of the new loan can be deducted against property 1. If property 2 is a rental property, the interest on $100,000 of the loan is deducted against property 2. If one of those two properties is for personal use, then the interest on that portion is not deductible. Or if you use the money for some other person purpose, it is not deductible. Using money for rehab is a qualified use if it is an investment property and you can trace the funds. Keep your rehab receipts separate. You can't just say you used it for rehab, you need a paper trail to prove it. Read up on IRS tracing rules. The money should be placed in separate accounts and tracked separately. One of the most common BRRRR mistakes is not property claiming interest on refinance.

@David V. Joe's right.  I would also talk to a CPA who is a RE investor.  You will want to button that up because the interest deduction would fall on your 1040, and you would want it falling somewhere else on your tax return (schedule E, business return, or the like).  

@David V.

I confirm that @Joe Splitrock is correct. Deductibility follows what the money is used for.

The prorated portion of the interest corresponding to the $80k is deductible against the original rental property.

The interest portion corresponding to the $100k is deductible or not depending on how you use the money. If you bought another rental - then deductible against that new rental. If you bought toilet paper - then not deductible, unless the TP is for your AirBnB.