Refinancing a house in USA from investment property to primary residence tax issues

Question

I am buying a house (I live in USA and this whole question is about tax situation in USA). But it used to be someone’s investment property and comes with the addendum that current tenants get to live for another 6 months (when their lease ends).

Due to this, the mortgage I need to use for this house is that of an investment property (since I won’t be living in it for another 6 months after purchasing).

So now I have the mortgage rate of an investment property - 3.5%

After 6 months, I move into the house. By that time, interest rates would have gone up and probably interest rate on primary residence loan itself would be 3.5%

So I thought - “what’s the point in refinancing. I will end up wasting the fee associated with refinancing.”

I googled that it could cost up to 3% of remaining principal amount to refinance.

But a friend said that if it’s an investment property, you cannot claim the tax deductions on the loan interest (even if I am living in it). Is he correct?

It seems like I get worse of both worlds - higher rates associated with investment property, but no tax benefit of a primary residence loan (even if I am living in it).

How does IRS decide if it is an investment property or a primary residence? Does it go by the fact if I a living in it or not? Or does it go by what kind of mortgage loan was used?

Answer 1

But a friend said that if it’s an investment property, you cannot claim the tax deductions on the loan interest (even if I am living in it). Is he correct?

I am assuming you are talking about renting the entire house, and not just a room.

• If the house is rented or available for rent, then the interest on the loan is used to offset the income from the rent. You can't deduct the principal amount of the monthly mortgage payment but you can deduct the interest.
• If you are living in the house for more than 14 days a year, then your ability to deduct interest is limited. But, if you are itemizing on your taxes the interest on your house can be deducted from your personal taxes. Due to the 2017 tax changes many people with mortgages take the standard deduction, but some still can itemize.

How does IRS decide if it is an investment property or a primary residence? Does it go by the fact if I a living in it or not? Or does it go by what kind of mortgage loan was used?

The IRS looks at: are you living in the house? Are you trying to rent it out? Are you renting it out at fair market value.

Regarding the type of mortgage. There is no difference in the loan, except for the lender requirements. It doesn't look any different on your tax forms. The IRS doesn't know if you put down 20% because you wanted to or the lender required you to do so.