How Do We Deduct Interest on a Loan to Refinance a Real Estate Investment?

By Robert Allen Kosbie, CPA, CFP, MBA

We own an apartment building worth more than $1 million. The loan has a balance of $110,000 that is due at the end of the year. We must refinance, but lenders don't want loans that small. If we borrow more, can we deduct the interest as a business expense? If we pay the loan off with proceeds of an equity loan on our home, can we deduct the interest as a business expense? If not, can we deduct the interest as a personal itemized deduction?

I understand the problem you face with refinancing your loan when lenders prefer not to lend the amount desired. The answer to your questions regarding business interest deductions when borrowing a larger amount to meet lender requirements or borrowing on a home equity loan is it depends.

Ultimately, the answer will depend on how you use the proceeds and will involve interest-tracing rules. The amount used to pay off the current debt would be traced to the rental property and still be deductible against the rental property income. Any additional debt would be deductible against the rental property only if you used the proceeds for the rental property (e.g., repairs and upgrades). Any additional proceeds used for personal matters, including investments, would not be deductible as business interest. They may be deductible, however, as personal mortgage interest or investment interest depending on your situation.

Robert Allen Kosbie, CPA, CFP, MBA, is a tax manager in the San Francisco office of RINA Accountancy Corp.

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