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I currently have my home all paid off. I am thinking about purchasing another property as my primary home, and renting out my paid off current home. My question is should I:

  1. Get a regular loan for the additional property
  2. Get a cash out refinance on my current home and then claim the interest on this new loan as an expense and use the proceeds from the re-fi to purchase the other home.

Basically can I claim the interest on the refi as an expense?

(This is for California)

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Publication 936 addresses this.

You are welcome to borrow up to $100K from this house to do whatever you wish, and it would be deductible. As littleadv stated, with proper paper trail you can borrow to invest. But as I read pub 936 I'm not seeing where it counts as an investment to buy a new home to live in.

Unless under $100K, I recommend financing the new house in the usual way, a mortgage secured by that house.

  • Thanks @JoeTaxPayer. However as I read publication 936 page 2 (Part I), it specifies the following (acquisition debt). Thoughts?: Mortgages you took out after October 13, 1987, to buy, build, or improve your home (called home acquisition debt), but only if throughout 2012 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately) – KingKongFrog Apr 19 '13 at 17:53
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    Right, a loan on house 1 does not count as acquisition debt for home 2, as far as I know. If you do it, keep a paper trail to prove that how it went, and it's only if you are audited you need to show this, but I'd not be surprised if it's now allowed. Tax code doesn't always address each and every precise issue. – JTP - Apologise to Monica Apr 19 '13 at 18:35
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What you should do is up to you. You can talk to a licensed financial adviser to get an advice.

But re the question in the subject line - NO, cash-out interest is not deductible on its own right, unless its a HELOC for less than $100K.

If you use the money for investment, you can deduct it as an investment expense (against the investment income) under certain conditions, and you should discuss with your tax adviser (EA or CPA licensed in California) the details of such transaction.

  • @littladv Isn't this considered (acquisition debt). Check out figure A in publication 936: Were all of your home mortgages taken out after October 13, 1987, used to buy, build, or improve the main home secured by that main home mortgage or used to buy, build, or improve the second home secured by that second home mortgage, or both? A:Your home mortgage interest is fully deductible. – KingKongFrog Apr 19 '13 at 17:56
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    @KingKongFrog I believe you will be going contrary to regulations (doesn't mean contrary to law necessarily, but you'll have to be able to prove your point in court). Generally, if the loan was not directly used to finance the acquisition of the property it is secured by - it is not considered as an acquisition loan by the IRS. You'll have to talk to a good tax adviser (EA/CPA, not an un-enrolled professional) or a tax attorney to check if a position like this has been discussed in a court that you're in the jurisdiction of, and what the decision was. – littleadv Apr 19 '13 at 18:37
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    @KingKongFrog in your case the loan is not secured by the property which you bought with the proceeds of the loan, even though the property you bought is indeed your primary residence, hence your problem – littleadv Apr 19 '13 at 18:38

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