Investment Interest on sold property

[TKTax]

Client refinanced his personal home to partially finance an investment property. We have been allocating a portion of interest as investment interest.

He has now sold the investment property, but still has most of the loan on his home. Can we continue to take a portion of the interest as investment interest?

[Pacun]

No. I think you will have to put everything back to mortgage interest. Technically (and without any paperwork), the investment property paid off "its" loan to the personal home. So now the whole loan went to the house.

Again, technically, he received the money from the sale and put it on his right pocket, then he pulled out the amount of the outstading loan and paid it to the house. Since he still needed that money, he put it on his left pocket, so now the house is the one using the whole proceeds of the loan.

Any other approach?

[imjulier]

I agree with Pacun. Mortgage interest subject to limitations if they apply.

[Abby Normal]

I don't think any of us follow the Interest Ordering Rules completely, either because we don't fully understand them or because it's too much work.

http://www.irs.gov/publications/p535/ch04.html#en_US_2013_publink1000243081

Also, once you elect to treat part of your home equity interest as not secured by the home, you need IRS permission to revoke that election:

http://www.thefreelibrary.com/Election+not+to+treat+debt+as+secured+by+a+qualified+residence.-a0110741604

You would have been better off taking it all as acquisition and home equity interest instead of allocating it to investment interest.

[Abby Normal]

You can also elect to treat some of the capital gain from the sale of the land as investment income to allow you to deduct the investment interest that's suspended on the 4952.