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Q. I own a rental house with a balance of $330,000 on the mortgage. I can refinance at a lower rate and a new balance of $332,000. Is the new loan’s interest fully deductible or is there nondeductible interest expense for the closing costs?
You can deduct the interest on loan proceeds that are used to buy or improve a rental house on IRS Form 1040 Schedule E, subject to passive activities loss limitations. For instance, if your annual rent income is $30,000, depreciation expense is $10,000, other expenses (taxes, insurance, repairs, etc.) are $10,000, and interest expense on the loan is $15,000, so the net loss from the property will be $5,000.
You can deduct expenses to refinance over the life of the loan. For example, if you obtained a 20-year $332,000 loan to replace $330,000 loan, with the $2,000 difference being the loan closing costs, you would deduct $100 amortization expense each year for 20 years.
The interest on the entire $332,000 is deductible, assuming the interest on the $330,000 loan was deductible (as purchase money loan or proceeds used to improve the property). The interest on the additional $2,000 principal ($332,000 new loan minus $330,000 old loan) is deductible as interest related to the loan related to the rental activity.
G. Scott Haislet, CPA, Esq. is a tax adviser, estate planner and real estate attorney. He can be reached at (925) 283-1031.
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