Refinances on Rentals
The same applies to refinances for your rental properties. Let’s assume that one of your rentals in Arizona has appreciated in value over the last few years. You want to continue holding on to the property but don’t want to leave all of that equity in there. Instead, you plan to do a cash-out refinance on that property and end up using that money to buy another investment property in Minnesota.
In that scenario, the interest is still deductible as a rental expense. Although the loan is secured by the Arizona property, you would deduct the interest against the Minnesota property, because that is the property that the loan proceeds were used for.
One thing to keep in mind is that at the end of the day, it does not really matter that the loan on the Arizona property was deducted against the Minnesota rental. The reason is, for most investors, all of the rental income and expenses of the various properties may be netted together at the end of the day anyways. So, the end result is that the interest expense on the new loan should be fully tax deductible.
Just like primary home loans, you will want to have a clear way of showing that the loan proceeds from the rental refi were used for other rental properties. This helps to ensure that the interest remains tax deductible in the event of an IRS audit.
Just like above, if you refinanced your rentals and used that money for personal things or vacations, the interest on that portion may no longer be tax deductible.