Personal residence changed into rental

[peggysioux]

Taxpayer refinanced their primary residence and took out $150,000 to purchase new house. Once new house was purchased, they turned the original home into a rental. From what I have read, the interest is neither deductible on the rental due to tracing rules nor deductible on schedule A because loan not based on equity from principal residence. My question is can the taxpayer get a new loan based on equity from their new primary residence to pay off the $150,000 and thus making the interest deductible on schedule A?

So many taxpayers are using the equity in their first homes to purchase a second home thinking the interest will be deductible and they are not very happy when they find out differently.

[jainen]

One has to wonder why

>>can the taxpayer get a new loan based on equity from their new primary residence<<

Sure, at least theoretically. One has to wonder why they didn't just get a purchase loan to begin with. The most common reasons are that they need 100% financing because they don't have a down payment and the property won't qualify for a favorable loan.

You also have to consider the bottom line. Closing costs might be five to ten thousand on a new loan, and it could be several years before the tax savings break even. By then they might want to refinance for a different reason. Remember that only interest on the first $100,000 would be deductible anyway.

[lbbwest]

I disagree Jainen per Pub 936 total mortgage interest

will be deductible if secured by primary residence.


Refinanced home acquisition debt. Any secured debt you use to refinance home acquisition debt is treated as home acquisition debt. However, the new debt will qualify as home acquisition debt only up to the amount of the balance of the old mortgage principal just before the refinancing. Any additional debt is not home acquisition debt, but may qualify as home equity debt (discussed later).

Did you miss me? lbb

[peggysioux]

If he refinances the

$150,000 and the refi is secured by the taxpayer's new home; wouldn't the total $150,000 be considered acquisition debt rather then equity debt. The $150,000 was truly to acquire new primary residence; however taxpayer took original loan against a rental to purchase new home being unaware that interest would not be deductible.

[jainen]

a good point

>>wouldn't the total $150,000 be considered acquisition debt rather then equity debt<<

It's a good point, and I'll have to think about it. But I'm pretty sure that the rule does not apply here because even though the loan proceeds can be traced to the purchase, you are not refinancing qualified home acquisition debt. The AMOUNT of home acquisition debt can never be increased with a refinance.