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Consolidating loans on investment property with primary residence mortgage

Forum|Forum|6 years ago
November 30, 2019
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I have three mortgage loans : 2 on investment properties and one on primary residence. They are about 333k each. I can refinance primary residence with cash out to total of 1m loan and pay off investment property loans. My net cash out is 0. Reason: investment property rates are higher by at least 1 percent. Question: can I continue to deduct the interest reported on 1098 for primary residence on schedule E as usual? (Upto 333k each)

Best answer by NCPERSON1

@Carl11_2 securing of property and foreclosure is a concern for the lender. If lender A gives you a loan for property using your property as a collateral, versus lender B gives you the same loan, at the same terms w/o securing your property, how does it affect IRS? So long as you are paying interest, it is an expense out of your income.

IRS should be happy that I have reduced my total interest and deductions. They benefit from it as much as I do. It is only the lender who wants to charge me arm and leg for rental property loses.

what am I missing?

suggest at this point, as there is so much savings at stake here, spend just a tiny bit of that savings by hiring a local CPA. That way you have 'piece of mind' that you are making the right decision for your circumstances. I don't think an anonymous public board is going to get you to that 'piece of mind' requirement.

A

Anonymous

can I continue to deduct the interest reported on 1098 for primary residence on schedule E as usual? (Upto 333k each)

this makes no sense since interest on primary residence is reported on schedule A.

however. if you refied your primary for $1 million, IRS tracing rules would still require that amounts used to pay off loans on investment property, still be attribute that property and deducted on schedule E.

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hindsight2019Author

I will restate. I refinanced my primary mortgage. $1m is reported on 1098. I had used $333k x 2 to pay off investment loans, abd $333 loan on primary home.

Does my tax return look the same before and after refinance?

Carl11_2

Employee

No, you can't claim one single penny of mortgage interest on SCH E because the rental property is not used in any way, form or fashion to secure the loan. You're also not investing any of the loan money back into the rental property since there is no "cash out" money to do that with. The new loan is secured only by your primary residence. Therefore all of the interest can only be claimed on the SCH A. Furthermore, due to SALT limits (State and Local Taxes) as well as mortgage interest limits, you're limited to deducting the interest on "only" the first $1M of the outstanding balance on the new loan, and a maximum of $10K for your SALT deductions.

What you may "save" in interest, you will "pay" in taxes a few times over.

Additionally, it doesn't make sense to refi any loan if the interest rate isn't "at least" 2% lower. If the new loan results in a "savings" of 1% on the interest rate, you'll never recover or even break even with the refi and closing costs you'll pay. Think this through long term. Short term savings now will cost you dearly later.

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NCPERSON1

<<you're limited to deducting the interest on "only" the first $1M of the outstanding balance>>

@Carl11_2 - I'd argue that he can't deduct the interest related to the entire $1mm loan against the primary residence, as "cash out" interest can only be deducted if the principle was reinvested to improve that primary residence. And the idea would use the 'cash out' to pay off another loan unrelated to the primary residence and not to improve that primary residence. If the loan was collateralized against all three properties, I think it could work (but creates problems if you later want to sell one of the properties and not all three at once - you may have to refi again)

@hindsight2019 further, I'd suggest obtaining documentation of any "traceability provision" from an IRS source before executing on the strategy; the publication link I provided doesn't take about that,

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hindsight2019Author

The 1% proposed savings on my loan are net savings (with zero closing costs), hence in my interest in the strategy.

if I buy a rental property from the cashout of the primary residence, that interest is deductible as investment interest even though the rental property is not a collateral in the Cash out Refi. Right?

A

Anonymous

under reg 1.163-10t(o)(5)(i) a taxpayer may elect to treat mortgage debt as not secured by a qualified residence. also see reg 1.163-8T

example from 10T

i) C borrows $60,000 secured by a qualified residence. C uses (within the meaning of § 1.163-8T) $20,000 of the proceeds in C's trade or business, $20,000 to purchase stock held for investment and $20,000 for personal purposes. In 1990, C pays $6,000 in interest on the debt and, under the rules of § 1.163-8T, $2,000 in interest is allocable to trade or business expenses, $2,000 to investment expenses and $2,000 to personal expenses. Assume that under paragraph (e) of this section, $2,500 of the interest is qualified residence interest and $3,500 of the interest is not qualified residence interest.

(ii) Under paragraph (e)(4)(iii) of this section, C may allocate up to $2,000 of the interest that is not qualified residence interest to any of the three categories of expenditures up to a total of $3,500 for all three categories. Therefore, for example, C may allocate $2,000 of such interest to C's trade or business and $1,500 of such interest to the purchase of stock.

U

u0d4n7a0p

@hindsight2019

What did you finally do/figured out? Can you claim the interest in Schedule E and claim that as an expense on rental property?

A

amesfans8721

@hindsight2019

i would like to know the outcome too please?

Carl11_2

Employee

I've searched all over the IRS website for documentation concerning what I guess would e called a "mixed use" type of secured loan, and I can't find jack squat that comes anywhere close to your situation. But from what I can find in IRS Publication 536 at https://www.irs.gov/pub/irs-pdf/p936.pdf on page 3, it appears things aren't what you're expecting.

From my interpretation, whatever you claim as mortgage interest must be secured by the real estate the mortgage is for. Furthermore, there's a limit on mortgage interest for a refinanced loan. In the case of a cash out, you can only claim the percentage of interest paid on the new loan, that is equal to the percentage of the new loan that was used to pay off the original amount owned on the original loan.

So if your mortgage balance before the refi was $50K and you refi'd for $100K, that means $50K of the new loan (50% of the new loan) was used to pay off the old mortgage. So only 50% of the interest paid on the new loan loan is deductible on SCH A for the life of the loan.

Since the remaining $50K was not used to improve the home that secured the new loan, it's not deductible at all.

The clarity you're looking for, I can't seem to find anywhere. With my current line of thinking, since that $50K you cashed out and used to pay off the rental is not secured by the rental (it's secured by the primary home you refinanced) I believe it's not deductible on SCH E, or anywhere else for that matter.

But I also interpret it that, if you had used that money to go out and "buy" a rental property, then it would be deductible on the SCH E.

Overall, I highly recommend you spend a few bucks of that cash out for professional help. Would also be nice if they could provide you a citation on the IRS website (which you could share here) that clarifies things one way or the other.

A

Anonymous_

Employee

@Carl11_2 wrote:

I've searched all over the IRS website for documentation concerning what I guess would e called a "mixed use" type of secured loan, and I can't find jack squat that comes anywhere close to your situation.

You simply had to read through this thread; the answer (posted multiple times) is right here.

[Section 1.163-10t(o)(5)(i) - which is also more or less spelled out in Publication 936]