Q: I could not find the exact answer I needed in my research. I converted my former primary residence into a rental property this year. I had an existing home equity/debt consolidation loan on this property. I discovered today that I cannot deduct my entire primary mortgage payment (only the taxes and interest). I was under the mistaken impression that the mortgage principal payment was a business expense. Does the same thing hold true for the home equity loan? Can I only deduct the taxes/interest on this as well or can I deduct the entire payment? Again, excuse my ignorance if this is a stupid question and the same rule applies. I want to do the right thing and avoid trouble with the IRS!
A: -You can only deduct interest and taxes (not the entire mortgage payment) but there are other deductions associated with rental property such as depreciation. If this is your first rental property tax return you should probably see a local accountant this year, maybe next year use a program like TurboTax. -I don't believe you can deduct any interest on the home equity loan after you place the rental asset in service, or establish a new primary residence. the reason is that this loan is not secured by your primary residence. You can only deduct interest for acquisition debt -- that is, a loan taken to purchase the business asset. If the home equity loan was used for a business purpose, for example repairing or remodeling the rental unit, then it would be deductable. note that the regulations have some specific requirements about how the money obtained from a loan is accounted for, or the IRS will assume the loan was for personal, not business purposes. Loan principal payment is never an expense. However, the asset purchased by use of that principal is expensed through annual depreciation charges. If you own a new primary residence it may be advisable to get a home equity loan on that property and pay off the one on the rental. Note that if you are renting long term (year or more), you can deduct tax and interest expense before conversion on sked A, and tax and interest (and other expense) after conversion on sked E, without having to follow the "vacation rental" rules which normally kick in if you rent more than 14 days a year but otherwise use the property yourself.