Many investment properties require additional investments over time, whether it’s doing maintenance or making improvements. One option for paying for those expenses is to use an equity loan. When you borrow money to buy or improve your investment property, the interest you pay on the loan may be able to reduce the amount of investment income you have to pay taxes on.
To claim the deduction, you must use the proceeds of the equity line for investment purposes. If you use a portion for personal expenses, you can’t deduct that portion of the interest on the equity line. Where you claim the deduction depends on whether your investment property is a rental property or one you just own.
If the investment property is a rental property, you'll report the interest expense on line 12 of Schedule E. Otherwise, you'll report it on line 9 of Schedule A.
Deducting Interest Expenses
If the investment property isn’t a rental, you report your deductible interest income on Schedule A, which means you must itemize your deductions. Typically, you start by figuring your investment interest deduction using Form 4952. However, you don’t need to complete Form 4952 if your investment interest expenses are less than your investment income from interest and ordinary dividends minus any qualified dividend, you don’t have any other deductible investment expenses, and you don’t have any disallowed investment expenses from the prior tax year. Once you know your deduction, report it on line 9 of Schedule A.
If you have rental income from your investment property, you report the interest paid on Schedule E. The amount of the deduction goes on line 12 and reduces your rental income for the year.
Limits on Investment Interest Deduction
If you claim your deduction on Schedule A, your deduction for investment interest cannot exceed your net investment income for the year. For example, if your net investment income for the year prior to your investment interest deduction is $4,000, and you have $5,000 of investment interest paid during the year, you’re only allowed to deduct $4,000. However, you can carry forward the remaining $1,000 to the next tax year, so the deduction isn’t lost completely.
Home Equity Indebtedness
The Tax Cuts and Jobs Act disallows the deduction for interest on home equity loans for the 2018 through 2025 tax years. However, this disallowance only applies to home equity indebtedness, which refers to debt secured by a primary residence that isn’t used to acquire the home.
For example, if you took out a home equity line of credit and used it to buy a new car, that would be home equity indebtedness. As long as you are using your investment property equity line to produce income, you can still deduct the interest on your taxes.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."