There can be many benefits to investing in property. Two such potential advantages are cash flow and property appreciation. Another potential advantage when it comes to real estate ownership involves interest expense. In other words, if you used any kind of mortgage to buy or refinance your property, you could be looking at a tax deduction.
Interest Rules, According to the IRS
If you google the question “is interest paid on investment property tax deductible?” you might come up with some very confusing and convoluted explanations and suggestions. On the one hand, the issue is fairly clear-cut if your mortgage is on your primary residence. You can deduct home mortgage interest up to a certain amount.
But plug in the search term “mortgage interest deductions on commercial property,” and the responses become more confusing. Some websites suggest that you can deduct that interest, while others are somewhat vague about the topic. As such, the best source to answer the question about interest payments and tax deductions is the Internal Revenue Service, or IRS. And, this question is answered in the IRS’ Publication 527 and 535.
Publication 527 states categorically that “you can deduct mortgage interest you pay on your rental property.” However, before doing a happy dance and pumping your fist in the air, the document provides a caveat when it comes to refinancing. Specifically, if you decide to refinance your rental property for more than the previous outstanding balance, “the portion of the interest allocatable to loan proceeds not related to rental use generally can’t be deducted as a rental expense.”
In other words, if you decide to refinance that rental property in order to obtain more liquidity for upgrades or improvements, the interest on the portion of that loan used for renovations generally cannot be deducted. It’s not being used for rental use.
IRS Publication 535 goes a little more in-depth about mortgage interest and deductions, with the following:
- In most cases, mortgage interest paid or accrued on owned real estate is deductible. But rather than deducting the interest currently, you might have to add it to the property’s cost basis in a process known as capitalization of interest.
- Capitalization of interest is used in the production of real property. In other words, this would be used if you’re building it from the ground up or, in some cases, decide to gut and renovate it.
- On another topic, if you pay off your mortgage early, and end up paying your lender a penalty, that penalty can be deducted as interest.
What’s not considered deductible when it comes to interest? Expenses paid to obtain that real estate mortgage in the first place. Specifically, mortgage commissions, abstract fees, reporting fees and the like cannot be deducted as interest. They are considered capital expenses.
Interest Paid on Investment Property
Can Be Deducted If . . .
So, the basic answer as to whether you can deduct the interest you pay on your investment property’s mortgage is yes, with caveats. You can’t deduct expenses related to obtaining that mortgage. And, if your mortgage is being used for property creation, you might have to capitalize that interest, adding it to the cost basis. And, if you ended up paying mortgage interest of $600 or more, on property you use for business or investment purposes, keep an eye out for the Form 1098 or similar statement, which will tell you how much interest was paid.
Finally, if you have any questions at all about what is deductible, and what needs to be considered a capital expense, be sure to keep your tax advisor’s email or phone number handy. Tax laws and requirements are constantly shifting. While mortgage interest is currently deductible, the definitions could change at any time.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor.