apportioning interest and principal

[wayside]

I use my HELOC on my house for a bunch of things - stuff on my primary residence, stuff for my rental properties.

I apportion the interest between the various different properties based in the percentage of the HELOC balance used for each property, and for the rentals I deduct the interest for each building as "other interest".

When I pay down the principal, how to I apportion it to the various properties? Can I choose which property to allocate the principal to?

Example: I have a $200K balance on my HELOC. $100K was used on improvements to my principal residence, $100K was used on a rental.

I pay down $5K of the balance.

Do I now owe $97.5K on each? Or can I allocate the entire $5K to my principal residence, for example, making the balances $95K and $100K?

[Diane Kennedy]

Now that's an interesting question. I would be inclined to apportion, but the reality is I can't think of a single reason why you would have to. If you borrowed money from one source for personal expenses and borrowed from another source for business, you aren't obligated to pay them back at the same time.

How is that for a wishy-washy answer?

[wayside]

Wishy-washy? Nah.

The issue for us is that we bought a property for cash out of our HELOC and then refi-ed it and paid back the HELOC. I really want to allocate the money I paid back to that property and not have to split it up.

So that's what I will do! Thanks!

[wayside]

Quick follow-up:

If I finance a repair on a rental by using my HELOC, can I deduct that interest?

[Diane Kennedy]

Yes, the interest is deductible.

[wayside]

If I pay property taxes for a rental out of a HELOC, is that interest deductible?

I guess more generally - if I use money from a HELOC for any reason on a rental, is that interest deductible?

[Diane Kennedy]

If you use HELOC (or any other borrowed funds for that matter) for a rental property, the interest will be a rental expense.

So if you use a credit card to repair the roof on your rental, the interest on the credit card will be a rental expense too.

You can see where it gets really confusing if you're commingling borrowed funds. Is that debt due to the ski vacation or the new roof?

[wayside]

You can see where it gets really confusing if you're commingling borrowed funds. Is that debt due to the ski vacation or the new roof?

Yep, I keep pretty careful track of which dollar went for what purpose. Currently 38.79% of my HELOC balance is allocated towards my rentals.

Thank god for spreadsheets.

[jeffinca]

I would be inclined to take whatever expenses I could on Schedule E - Rental Activities because that's "above the line" instead of as home mortgage interest, which is "below the line." There are huge consequences to each that become very specific to your own situation.

For example, if I were a high wage earner and my itemized deductions were being phased out and I was subject to AMT, I'd be inclined to take as many expenses as possible on Sch E rather than Sch A.

However, if I were limited by the $25,000 passive loss limitation, I'd rather take the deduction on Sch A to get it as a current year deduction instead of later years when I had more profits from rentals or in the year of disposition of that property.

You can borrow on your HELOC and take the mortgage interest deduction on Sch A for ANY reason, rentals included. So I'd opine that it's the taxpayer's election where to take the deduction, just so long as you didn't try to take it in both places, of course!

One very important word of caution on HELOC's... interest on original acquisition mortgages is limited to interest on the first $1 Million, and interest on a home equity (non-acquisition, not necessarily HELOC) is limited to $100k... but ONLY IF there exists sufficient equity to support that $100k of debt.

In other words, if you bought a $100k house with an $80k first and $20k down, then borrowed $50k after the house appreciated, you have $80k acquisition debt and $50k home equity debt. If the house came back down to $100k in value (could even be worse), then you'd only be able to deduct the interest on the $80k loan plus interest on $20k of the second.

You can only deduct the interest on a home equity (non-purchase money) loan up to $100k to the extent there exists sufficient equity in the home in that tax year to support that amount. I suspect the IRS will start auditing for this exact issue now that HELOC's are becoming totally exposed with no equity.

Sorry, I digress from the OP's question. I think you should take the interest deduction wherever it suits you best. You're allowed to take it on E or A. An auditor might try to make you take it on Sch E, but then I'd argue that HELOC interest on your trip to Hawaii is allowed so the interest on whatever you used your HELOC for should similarly be allowed on A, assuming you're in the $25k limitation scenario.

Diane, does that make sense to you? Based on the IRC that I know, it really comes down to taking the deduction wherever you're entitled.

[wayside]

interest on a home equity (non-acquisition, not necessarily HELOC) is limited to $100k.

My understanding is that the HELOC/HE interest deduction is limited to the interest on $100K of debt in excess of that used to acquire or improve the property. That is, if I take out a HELOC for $200K to put a big addition on my house, I can deduct all the interest.

The HELOC interest gets allocated to the property the money was spent on, and taken on the appropriate schedule (E for my rentals, A for my home). My HELOC balance is well over $100K and because of that I don't think I can just arbitrarily allocate the interest however I want.

I suspect the IRS will start auditing for this exact issue now that HELOC's are becoming totally exposed with no equity.

Will the IRS be required to prove that the equity doesn't exist or will the homeowner be required to prove that it does?