Question

Can I deduct 401k mortgage on an investment property

Forum|Forum|7 years ago
June 3, 2019
11 replies
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I currently have a mortgage on an investment property. If I take out a general loan from my 401K, would I be able to write off anything associated with the loan on my taxes as an expense on my investment property?

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Carl11_2

Employee

What kind of investment property? Raw land? Residential Rental Real Estate? Something else?

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TB41115

I PURCHASED A NEW HOME WITH FUNDS FROM MY 401K. AM I ABLE TO WRITE ANY OF MY DOWN PAYMENT OFF?

Carl11_2

Employee

Nothing associated with the 401(k) loan is deductible. Your only deductions are on the mortgage obtained from the lienholder who holds the mortgage.

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TMT

See other intuit thread - daveandrade89 states that There are actually situations where the interest on a 401(k) loan would be deductible, but they are very rare. For example, let's say you were borrowing from your 401(k) to finance the purchase of a rental property -- this interest would be considered deductible if (and only if) the funds you are borrowing from your account are NOT your own elective deferrals. Essentially, you'd have to borrow exclusively from your employer's matching / profit sharing funds and have to prove that they were used for a deductible reason (i.e. a rental property). Now, not sure exactly how to prove that was done since when I borrowed from my 401k, there was no option to select ONLY from my employers matching funds, even though these were adequate to cover my modest loan.

Hal_Al

Employee

See https://ttlc.intuit.com/community/retirement/discussion/is-the-interest-on-the-loan-from-my-401-k-deductible-we-used-it-for-a-down-payment-on-our-primary/01/771353#M73681

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SweetieJean

Employee

Furthermore, while allowing loans within a 401k plan is allowed by law, an employer is not required to do so. If they do, they might do so only for specified reasons, so you may not qualify.

Carl11_2

Employee

Additionally, if you at any time become no longer eligible for that 401(k), like if you lose your job, the remaining balance of the loan is due and payable on demand. If not paid, then it automatically becomes a withdrawal. If that makes it an early withdrawal, then you'll be assessed taxes plus the 10% early withdrawal penalty, along with any other penalties the plan may allow.

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cmgutierAuthor

Thanks Carl! I am currently weighing my options of whether to refinance the mortgage with a financial institution or to take out a general loan against my 401K. The interest rates would be comparable, but the deciding factor would be whether I am able to write off some of the costs. Since deductions are only allowed on mortgages obtained from a lienholder, then I may have my answer. Thanks again.

Carl11_2

Employee

Of course, the best is to pay cash. But not everybody has that kind of money laying around. WIth a mortgaged rental property the depreciation and other stuff you get to deduct every year can easily offset the taxability of the rental income.

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cmgutierAuthor

Why pay cash for a rental when I can have the renter pay the mortgage. AND I can write off the PMI and interest as expenses against the income. So the cost to get a mortgages rental home would be less than paying all cash for a rental. To me, it only makes sense to pay cash if it is one's primary residence.

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SweetieJean

Employee

and what happens when that renter leaves?

Carl11_2

Employee

It's all about ROI (Return On Investment) percentages. Lets say I mortgage a property with $20K down and my payments are say, $800 a month. Then I rent it for $1500 a month. If the property is rented for every single month of the year, that gives me a $700/month cash flow which is an ROI on my initial $20K investment of 42% (forty two percent) a year on my initial 20K payment of *my* money.
Now it's "technically" not my money making the mortgage payments, but I am paying taxes on the principle part of that payment. So the actual "realized" return would be more akin to 30-35% ROI. Beat that on the stock market.
On the other side of that coin, if I pay $100K cash for a property and rent it out for the same $1500/mo, that's only an 18% return on the investment, again assuming it's actually got a paying renter in it for 12 months each year. Yes, it's a higher cash flow. But that $100K cash payment isn't working for me as well as it would if I used it to put a $20K down payment on 5 properties that I mortgaged and rented out for $1500/mo each.
Even so, the reality is there will be a month or two of no rental income between renters, and I know that. But still, even a 20% return for 10 months of rental income/cash flow is still better than anything else out there pays now.

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Taylor 9

Can you provide the code reference? Why would interest incurred on purchase of rental real estate not be deductable?

Carl11_2

Employee

You don't need a reference. The 401(k) loan is not secured by real estate of any kind, specifically it's not secured by the rental property it was used to purchase. If you don't pay back the 401(k) loan, then the 401(k) money is "garnished" to back back that loan - not the real estate. Therefore, the 401(k) loan interest is just flat out not deductible. Period.

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Taylor 9

The idea that only interest expense that is secured by the rental real estate can be deductible in a rental business is simply incorrect. There are specific tracing rules under Treasury Regulation § 1.163-8T that provide guidance for allocating interest based on how loan proceeds are used. Having said that, there are addition restrictions on the deductibility of 401k loan interest, I believe that kick in when borrowing against elective deferrals. That is the cite I was looking for, but I'll find it myself when I'm at a computer.