HELOC funds for improvements to an investment property: tax rule question

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ljwobker
Posts: 52
Joined: Sat Dec 06, 2008 5:30 pm

HELOC funds for improvements to an investment property: tax rule question

Post by ljwobker » Wed Mar 28, 2018 1:15 pm

Two major assets in play:
1) our primary residence, on which we have a 30yr fixed mortgage and a 50k HELOC, where the rate is (prime - 0.25%), and currently has a ZERO balance.
2) an investment property, on which we have a 15yr fixed mortgage and no other open accounts. It's currently rented on a multi-year lease.

We're looking at doing a pretty major renovation on the investment property: in the 50k-75k range. The property will remain rented/occupied (i.e. continue generating income) during the renovation work. My question is specific to the deductability/tracking of interest I pay on a loan used to improve/renovate that property. I can see three options on how to pay for the renovation work:
1) use funds removed from a taxable investment account. Here I have some switching costs, I will likely owe LTCG on whatever I sell to generate the funds, and I'm giving up the long-term average gains of a roughly 75/25 stock/bond portfolio. This combination points me strongly towards one of the two other options below:
2) draw 50k from the existing HELOC and use those funds to pay for the renovation.
3) take out a new loan (assume the same 50k number) specifically for the purpose of funding this renovation work.

Some thoughts:
The best rate I can find for option 3 is roughly 4.85%, or ~60bp higher than option 2. This and the convenience of using an existing account makes me lean towards #2. The open question is whether or not I need to treat these differently from a tax standpoint - or "are there differences in the deductability of these two options?"

The HELOC on our primary residence is secured by said property, but the funds would be used to improve an investment property, which makes me think I can count that interest as an expense against the investment property (interest expense on schedule E).

Is this correct? Anything I'm not thinking about here? From a record-keeping standpoint is there anything specific I need to do? I guess to some extent I'm asking how I would "prove" that I'm using the funds for the investment property as opposed to something else -- would I need anything other than invoices/receipts from the various contractors and the loan statements?

oldmotos
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Re: HELOC funds for improvements to an investment property: tax rule question

Post by oldmotos » Thu Mar 29, 2018 8:29 pm

I have used my HELOC for rental property improvements and deducted the interest on the rental property many times over the years. My accountant thought it was ok but I was never audited so can not say for sure it meets IRS rules. I always figured my receipts would prove where the funds were used. The HELOC funds were much easier to access than getting a construction loan or other financing.

Lafder
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Re: HELOC funds for improvements to an investment property: tax rule question

Post by Lafder » Fri Mar 30, 2018 11:26 am

My accountant said the interest I pay on a HELOC I have on a rental is eligible to be counted as an expense against the rental income.

My understanding is that a HELOC on a primary residence, the interest can not be deducted/used as an expense, whatever you used the $ for.

I would find a way to have a HELOC not associated with your primary residence for maximum benefit. Or refi one of the primary loans.

The rules about HELOCs no longer being deductible on primary residences is a brand new rule.

lafder

Sandi_k
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Re: HELOC funds for improvements to an investment property: tax rule question

Post by Sandi_k » Fri Mar 30, 2018 12:56 pm

Lafder wrote:
Fri Mar 30, 2018 11:26 am

My understanding is that a HELOC on a primary residence, the interest can not be deducted/used as an expense, whatever you used the $ for.

The rules about HELOCs no longer being deductible on primary residences is a brand new rule.

lafder
Not entirely true. The new rule is that it's not deductible if it's a new HELOC. Lines of credit that already existed prior to the new tax law are still allowable, under $100k. So you're correct that this strategy will not work for the OP.

"Under the Tax Cuts and Jobs Act of 2017, though, the debt limit on deductibility for acquisition indebtedness is reduced to just $750,000 (albeit grandfathered for existing mortgages under the old higher $1M limit), and interest on home equity indebtedness is no longer deductible at all starting in 2018.

"Notably, though, the determination of what is “acquisition indebtedness” – which remains deductible in 2018 and beyond – is based not on how the loan is structured or what the bank (or mortgage servicer) calls it, but how the mortgage proceeds were actually used. To the extent they were used to acquire, build, or substantially improve the primary residence that secures the loan, it is acquisition indebtedness – even in the form of a HELOC or home equity loan. On the other hand, even a “traditional” 30-year mortgage may not be fully deductible interest if it is a cash-out refinance and the cashed out portion was used for other purposes."


https://www.kitces.com/blog/tcja-home-m ... ity-heloc/

Sandi_k
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Re: HELOC funds for improvements to an investment property: tax rule question

Post by Sandi_k » Fri Mar 30, 2018 1:02 pm

ljwobker wrote:
Wed Mar 28, 2018 1:15 pm
Two major assets in play:
1) our primary residence, on which we have a 30yr fixed mortgage and a 50k HELOC, where the rate is (prime - 0.25%), and currently has a ZERO balance.
2) an investment property, on which we have a 15yr fixed mortgage and no other open accounts. It's currently rented on a multi-year lease.

We're looking at doing a pretty major renovation on the investment property: in the 50k-75k range. The property will remain rented/occupied (i.e. continue generating income) during the renovation work. My question is specific to the deductability/tracking of interest I pay on a loan used to improve/renovate that property. I can see three options on how to pay for the renovation work:
1) use funds removed from a taxable investment account. Here I have some switching costs, I will likely owe LTCG on whatever I sell to generate the funds, and I'm giving up the long-term average gains of a roughly 75/25 stock/bond portfolio. This combination points me strongly towards one of the two other options below:
2) draw 50k from the existing HELOC and use those funds to pay for the renovation.
3) take out a new loan (assume the same 50k number) specifically for the purpose of funding this renovation work.

Some thoughts:
The best rate I can find for option 3 is roughly 4.85%, or ~60bp higher than option 2. This and the convenience of using an existing account makes me lean towards #2. The open question is whether or not I need to treat these differently from a tax standpoint - or "are there differences in the deductability of these two options?"

The HELOC on our primary residence is secured by said property, but the funds would be used to improve an investment property, which makes me think I can count that interest as an expense against the investment property (interest expense on schedule E).

Is this correct? Anything I'm not thinking about here? From a record-keeping standpoint is there anything specific I need to do? I guess to some extent I'm asking how I would "prove" that I'm using the funds for the investment property as opposed to something else -- would I need anything other than invoices/receipts from the various contractors and the loan statements?
See previous post. With the new tax law, neither #2 or #3 are deductible for you.

#2 because you're using the funds on your non-primary residence.
#3 because you're using the funds on your non-primary residence.

ONLY HELOCs taken out prior to December 2017 on primary residences - with a balance of less than $100k - AND where the funds were used for home improvements - are deductible.

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Rainier
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Re: HELOC funds for improvements to an investment property: tax rule question

Post by Rainier » Fri Mar 30, 2018 1:12 pm

Sandi_k wrote:
Fri Mar 30, 2018 1:02 pm
ljwobker wrote:
Wed Mar 28, 2018 1:15 pm
Two major assets in play:
1) our primary residence, on which we have a 30yr fixed mortgage and a 50k HELOC, where the rate is (prime - 0.25%), and currently has a ZERO balance.
2) an investment property, on which we have a 15yr fixed mortgage and no other open accounts. It's currently rented on a multi-year lease.

We're looking at doing a pretty major renovation on the investment property: in the 50k-75k range. The property will remain rented/occupied (i.e. continue generating income) during the renovation work. My question is specific to the deductability/tracking of interest I pay on a loan used to improve/renovate that property. I can see three options on how to pay for the renovation work:
1) use funds removed from a taxable investment account. Here I have some switching costs, I will likely owe LTCG on whatever I sell to generate the funds, and I'm giving up the long-term average gains of a roughly 75/25 stock/bond portfolio. This combination points me strongly towards one of the two other options below:
2) draw 50k from the existing HELOC and use those funds to pay for the renovation.
3) take out a new loan (assume the same 50k number) specifically for the purpose of funding this renovation work.

Some thoughts:
The best rate I can find for option 3 is roughly 4.85%, or ~60bp higher than option 2. This and the convenience of using an existing account makes me lean towards #2. The open question is whether or not I need to treat these differently from a tax standpoint - or "are there differences in the deductability of these two options?"

The HELOC on our primary residence is secured by said property, but the funds would be used to improve an investment property, which makes me think I can count that interest as an expense against the investment property (interest expense on schedule E).

Is this correct? Anything I'm not thinking about here? From a record-keeping standpoint is there anything specific I need to do? I guess to some extent I'm asking how I would "prove" that I'm using the funds for the investment property as opposed to something else -- would I need anything other than invoices/receipts from the various contractors and the loan statements?
See previous post. With the new tax law, neither #2 or #3 are deductible for you.

#2 because you're using the funds on your non-primary residence.
#3 because you're using the funds on your non-primary residence.

ONLY HELOCs taken out prior to December 2017 on primary residences - with a balance of less than $100k - AND where the funds were used for home improvements - are deductible.
I'm pretty sure you're wrong.

It doesn't matter if it is HELOC or a loan from a creepy guy on the corner...if the funds are being invested in an active real estate rental the interest would be deductible as an interest expense, offsetting rental income.

What secures the loan in this case does not matter, tracing the loan funds to the improvement expense is what matters.

ljwobker
Posts: 52
Joined: Sat Dec 06, 2008 5:30 pm

Re: HELOC funds for improvements to an investment property: tax rule question

Post by ljwobker » Fri Mar 30, 2018 2:03 pm

Rainier wrote:
Fri Mar 30, 2018 1:12 pm

It doesn't matter if it is HELOC or a loan from a creepy guy on the corner...if the funds are being invested in an active real estate rental the interest would be deductible as an interest expense, offsetting rental income.

What secures the loan in this case does not matter, tracing the loan funds to the improvement expense is what matters.
I"m relatively sure this is correct: I can't find anywhere in code or reference that any of these things matter:
- where the loan is taken from
- what, if anything, secures this loan

The only thing I *can* find is that the interest has to be paid on a loan that acquires or improves the property.

Sandi_k
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Re: HELOC funds for improvements to an investment property: tax rule question

Post by Sandi_k » Fri Mar 30, 2018 2:23 pm

I gave my source, with an active link - Kitces is a very well-respected PF blogger. What's yours?

I read it as HELOCs are now only deductible if they're acquired on a personal residence, and used for improvement on a personal primary residence - and the OP was specifically referring to a HELOC for his rental house.

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Rainier
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Re: HELOC funds for improvements to an investment property: tax rule question

Post by Rainier » Sat Mar 31, 2018 5:42 am

Sandi_k wrote:
Fri Mar 30, 2018 2:23 pm
I gave my source, with an active link - Kitces is a very well-respected PF blogger. What's yours?

I read it as HELOCs are now only deductible if they're acquired on a personal residence, and used for improvement on a personal primary residence - and the OP was specifically referring to a HELOC for his rental house.
Again this is wrong.

Only deductible as a personal mortgage interest expense as a HELOC. In 2017 that would be line 10 on Schedule A.

In this case it would go on Schedule E as an expense. Again, it doesn't matter if it is a HELOC or even a cash out car loan....if the money goes to the rental property it is a business expense.

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Rainier
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Re: HELOC funds for improvements to an investment property: tax rule question

Post by Rainier » Sat Mar 31, 2018 5:54 am

The problem is, you are obsessed with the word HELOC. Let's try something else.

You own your car outright, no loans, and it is worth $20,000. You need some cash so you take out a car loan from Penfed for $10,000 and pay it back over 5 years. Is the interest deductible? Depends....

1) Use the cash to buy another car for personal use: No

2) Use the cash to buy Amazon stock: Yes, Schedule A, investment interest

3) Use the cash to buy a car that you drive 100% for Uber: Yes, Schedule C, interest expense

4) Use the cash to improve your rental property: Yes, Schedule E

5) Use the cash to improve your own house: No...and that's the tricky one.

ljwobker
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Re: HELOC funds for improvements to an investment property: tax rule question

Post by ljwobker » Tue Apr 03, 2018 4:37 pm

Thanks for all the answers - at this point I'm convinced that I can do #2 (draw from an existing HELOC) and safely/legally write off the interest on Schedule E. For anyone who might care, my plan for making the tracking/accounting easier is to (again) start with a zero-dollar balance on the HELOC, and then just write checks from the HELOC account directly to the contractor doing the renovation. If I ever have to prove how the funds were used this seems about as clear as I can make it that the money was used to fund the renovation work.

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