taxes

Refinancing for rental property deduction

Judy O'ConnorDear Tax Talk,
One of my rental properties was bought with cash. There's no mortgage on it, so it generated profit each year to the IRS.

If I do a cash-out refinance, and those proceeds were used for another investment property (or to pay down my own primary residence), would I be able to deduct the interest on taxes? Anything I need to look out for? Thanks.
-- Sunny

Dear Sunny,
You'd like to refinance to get a rental property deduction. That's possible, but your losses may be limited.

Rental agreement © scyther5/Shutterstock.com

The mortgage interest on your rental property will be deductible on Schedule E. However, if the rental property goes from showing a profit as it does now to generating a net loss due to the interest deduction, your losses may be limited to passive losses. Let me explain.

Rental real estate activities are considered to be a "passive activity" by the IRS, and the general rule is that passive losses can be used to offset only "passive income." There is an exception if you or your spouse actively participates in the real estate activity; then you may be able to deduct up to $25,000 of losses from your nonpassive income. You should take a good look at IRS Form 8582, Passive Activity Loss Limitations, and see how it applies to your particular situation.

As far as paying down your home mortgage with the proceeds, you should check out interest rates for mortgages on the rental property. You may find out the rates are higher than what you are currently paying on your home mortgage because the rental property is considered an investment property. Since I do not know what your current itemized deductions are, you should see what happens on Schedule A if you no longer have the home mortgage interest deduction.

If you use the money to acquire another rental property and it is generating passive income, then that income may be offset by any passive losses generated by your first rental property due to the mortgage interest deduction.

Thanks for the great question.

Ask the adviser

To ask a question on Tax Talk, go to the "Ask the Experts" page and select "Taxes" as the topic. Read more Tax Talk columns.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

Bankrate's content, including the guidance of its advice-and-expert columns and this website, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this website is governed by Bankrate's Terms of Use.

advertisement

Show Bankrate's community sharing policy
          Connect with us
MORTGAGE HOME EQUITY AUTO CDs CREDIT CARDS
Product Rate Change Last week
30 year fixed, 0 point 4.30%  0.13 4.43%
15 year fixed, 0 point 3.30%  0.03 3.27%
5/1 ARM 3.34%  0.12 3.46%
 
View Rates in your area Next
Product Rate Change Last week
30K FICO-based HELOC 4.38%  0.09 4.47%
50K FICO-based HELOC 4.11%  0.06 4.17%
100K FICO-based HELOC 3.96%  0.03 3.93%
 
View Rates in your area Next
Product Rate Change Last week
60 month used car loan 2.63%  0.10 2.73%
48 month used car loan 2.90%  0.07 2.97%
60 month new car loan 3.17%  0.05 3.22%
 
View Rates in your area Next
Product Rate Change Last week
1 Year CD 0.90%  0.01 0.91%
2 Year CD 1.09% --0.01 1.08%
5 Year CD 1.74% --0.00 1.74%
 
View Rates in your area Next
Product Rate Change Last week
Balance Transfer Cards 15.66%  0.01 15.67%
Cash Back Cards 16.36%  0.03 16.33%
Low Interest Cards 10.87% --0.00 10.87%
 
Next
advertisement
DAILY TAX TIP NEWSLETTER

Get expert advice during tax season on tax preparation and tips for cutting your tax bill.

advertisement
While the courts duke it out over who is eligible for the Obamacare premium tax credit, the IRS chief says his agency will continu
Partner Center
advertisement

Connect with us