Mortgage Interest Tracing Rule

[NotEasy]

If you took a mortgage loan out from a rental property and used the proceeds to make improvement to your main home, is the mortgage interest deductible in any way?

A tax professional told me that according to the tracing rule, the use of the loan proceeds can be traced to the main home. So the mortgage interest can be itemized and deducted in Schedule A. Is it correct?

[veritas]

The loan

must be secured against the residence for it to be in any way deductible as home mortgage interest.

[NotEasy]

must be secured against the residence for it to be in any way deductible as home mortgage interest.

But the loan is taken out from a rental property so it is not secured against the main home. Does that mean the mortgage interest is not deductible at all?

[GIMoe]

Correct

But the loan is taken out from a rental property so it is not secured against the main home. Does that mean the mortgage interest is not deductible at all?

It shouldn't go on Sch E since it was not used for the rental property, it shouldn't go on Sch A since it was not secured by the main or second home. That makes it not deductible.

[jainen]

Another good example

>>That makes it not deductible<<

Another good example of why investment decisions should be evaluated on their own merits, and not depend on a tax effect for justification.

[erchess]

Say What???

You guys are telling me that to deduct mortgage interest on Sch E the principal amount must have been spent on the rental property securing the mortgage? What happens if you keep some of the proceeds as cash so that you will be able to meed unexpected future expenses? Also doesn't this fly in the face of the idea that money is fungible?

[veritas]

I'm not

saying it. The tax reform act of 1986 is saying it.

[erchess]

That's a very good point.

You and the others are not making things up, you're simply telling me and others what the tax laws of the US are. However, I am more distressed than ever because TRA 86 became law long before I became a tax professional. Can you cite a passage in an IRS Pub or the tax code or TTB that would back you up?

Also, what if the proceeds of the mortgage had been used to buy investments that were intended to yield taxable income?? Could we then treat the interest as investment interest?

[veritas]

If the money was in a taxable

income bearing account the interest would be deductible as investment interest.

[outwest]

The citations are..

Reg. Secs. 1.163-8T, 9T, and 10T

Happy reading.

[Davc]

Always keep in mind the basic IRC. All income is taxable. Nothing is deductible.

You only need specific cites for exceptions.