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An important detail on mortgage interest deduction for landlords

Question:

Does it matter how high my mortgages are on each property? Isn't the interest tax-deductible regardless on which property secures the loan?

Answer:

In many cases, it will not matter. However, I ran last year into a situation where I found out, it does matter for me now.

Simplified example:

- earned annual income of $110k
- primary residence, mortgage interest $50k
- 3 rental homes, total mortgage interest $50k
- 3 rental homes, total rent +$50k
- 3 rental homes, depreciation $50k

Taxable income:
+$110k - $50k - $50k + $50k - $50k = $60k

It all gets lumped together, about $60k taxable income.

Now a small change - higher earned income:

- earned annual income of $300k
- primary residence, mortgage interest $50k
- 3 rental homes, total mortgage interest $50k
- 3 rental homes, total rent +$50k
- 3 rental homes, depreciation $50k

Once the AGI is over $150k, you no longer can deduct passive losses (rental interest, rental depreciation) from earned income.

Taxable:

Earned income: $300k - $50k = $250k taxable
Rentals: -$50k + $50k - $50 = -$50k = a loss

You can carry this loss forward and it will help you when you sell those rental properties.

I personally am in that situation. I found out about it in November 2006. I wish I had found out about it in JANUARY 2006.

The solution is to maximize the loan on your primary residence. The following would look better:

- earned annual income of $300k
- primary residence, mortgage interest $100k
- 3 rental homes, total rent +$50k
- 3 rental homes, depreciation $50k

Rent and depreciation still cancel each other out.
But the taxable earned income goes from 250k to 200k.

It was too late to do something about that in November.


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