Dear Tax Talk,
How much of my home equity line of credit interest can I deduct on my tax return?
I am now buying a new home, which will be my primary residence. I will draw a $200,000 home equity line on my first house. I plan to rent this first house, if possible.
Can I deduct all the interest that I pay on the home equity line of credit that I used to buy my new home?
Unfortunately, your plan will leave you high and dry without a deduction. For you to take a home mortgage interest deduction (on Schedule A), your debt must be secured by a qualified home. This means your main home or your second home. It does not mean your former home or a rental property. If you borrow against your former home for any other purpose than to improve it, the interest deduction on this borrowing would be lost when you convert it to rental use.
So the question is, how can you use your accumulated equity to buy a new main home? You're going to have to sell your former home. This isn't such a bad idea, because remember, if you're married you can exclude up to $500,000 in capital gains if you have owned and lived in the home for two of the last five years. If you convert it to a rental property for more than three years, you lose the capital gain exclusion and will pay tax on the difference between the selling price and its original cost. My suggestion is take the cash out tax free by selling it, buy your home and buy another rental in this distressed market.
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