I can't get a grasp on the correct answer: If I borrow against
the equity in my home and use it to build a rental home, can I deduct the interest
expense on the amount over the $100,000 home-equity debt limit? If the answer
is yes, where is the interest expense deduction to be put on my tax return?
Could you expand on the ramifications of such borrowing and subsequent
use of the proceeds so far as the tax deduction of the interest
goes?! I am so frustrated in trying to understand the right way
to treat this interest expense!
The general rule is: You can claim, as an itemized
deduction, interest expense paid on a mortgage used to acquire your
principal residence and a second home. You can also claim, as an
itemized deduction, interest expense on an additional $100,000 in
borrowings without having to justify the use of the borrowing. However,
if you do use the additional borrowing for investments, or substantial
improvements to your home or homes, you can increase the $100,000
limit but can also change the character of the interest expense
and, therefore, where you claim the deduction.
You change the character by tracing the borrowing
to the use of the funds. In your case, you want to use $100,000
or more to build a rental property. Hence the interest on this debt
(even if it goes beyond $100,000) becomes deductible against the
Alternatively, you can claim the interest on $100,000
of the total debt as an itemized home-mortgage interest deduction
and the remainder against the rental income. You might want to allocate
some of the interest as an itemized deduction if the rental property
does not generate sufficient income to utilize all of your deductions
in the year.
might want to claim the interest on the $100,000 as itemized during the construction
period to avoid limitations on the deduction. However, you may want to open a
separate bank account to simplify the tracing of the borrowing to the construction
of the property.