Equity Loan on Rental to do home improv on residental home

[GTS1101]

I have a client who took out a second against her rental in the amount of 150,000. 40,000 of the loan was used to pay off her old second on the rental that was orignally used to purchase the rental. She used 59,000 to invest in a second home with her daughter. She is 50% owner on the new home with her daughter. She used 19,000 to do home improvements on her personal residence. The balance of 32,000 was used to payoff credit cards and a new car. Are there limitations on the amount of home mortgage interest you can deduct on rental properties? Do the same rules apply as the home acquisition rules and home equity limits to rentals? Do you use the same formula to calculate?. Or is the money down on the new house and the amount used for home improvement on her own residence not deductible because this loan is not secured by those residences? The amount to payoff cars and credit cards is that non-deductible personal interest because it has nothing to do with the rental.

Thanks!

GTS1101

[Bees Knees]

Only the interest allocated to paying off the rental loan is deductible. The rest is non-deductible personal interest.

The reason is loan proceeds must be traced to actual business or investment use in order for the interest on the loan to be deductible. Since some of the proceeds were not used in the rental business, that portion of the interest cannot be deducted against rental income, even if the mortgage company issues a 1098.

And since the mortgage is not secured by the taxpayer's first or second home as collateral for the loan (the taxpayer does not use the rental for a first or second personal residence), then the home mortgage interest deduction rules cannot apply.

[Roland Slugg]

Some interest deductible, some not

Dear GTS1101

In order for interest on a home equity loan to be deductible when the proceeds are used for personal purposes, the loan must be secured by the home itself. (Code §163(h)(3)(C)(i))

Interest on the new $150k loan will need to be allocated and treated as follows:

• Interest on $40k is deductible as rental interest.
• Interest on $59k may be deductible either as interest on a second home or as rental interest on the house owned with her daughter provided that (1) the mother charges her daughter fair market rent for the 50% share of the house the mother owns, and (2) the $59k does not exceed 50% of the cost of that house.
• Interest on $19k is not deductible even though the proceeds were used to improve her principal residence, since the loan isn't secured by that residence.
• Interest on $32k is non-deductible personal interest.

If the $19k and $32k had been borrowed separately and secured by the TP's personal residence, the interest thereon would have been deductible as long as the overall limit for home equity interest was not exceeded.

[Davc]

27% of the interest is deductible on Schedule E. (40/150). The rest is personal interest and not secured by a residence so not deductible.

[GTS1101]

Thank You!

Thank You! You have all been very helpful. I learn so much from this message board and I am grateful for your knowledge and expertise.

[S T]

Gts1101

GTS1101, I am so thankful that you are posting these issues, as I seem to have ongoing questions with this issue every year.

So the answers are probably assisting many of us.

Sandy