The rule, in one paragraph
The regulation allocates debt — and therefore the interest on it — "solely by reference to the use of such proceeds." The collateral is irrelevant to the allocation. Interest traced to a rental activity is reported with that activity on Schedule E and is not subject to the dollar cap that limits mortgage interest on a personal residence, because it is not personal residence interest at all. Interest traced to a personal expenditure is personal interest, which is not deductible. IRS Notice 89-35 and Publication 527 apply the same logic to rental owners.
Three draws, three answers
- Line on Rental A, used to renovate Rental A: rental interest, Schedule E for Rental A.
- Line on Rental A, used as the down payment on Rental B: rental interest, generally reported with Rental B, because that is where the money went.
- Line on Rental A, used to pay off a personal credit card or buy a boat: personal interest, not deductible, even though a rental secures it.
A draw split across uses is split for tax purposes in the same proportion, which is where records matter.
Keeping the trace clean
The practical advice every CPA gives: deposit the draw into a dedicated account and pay the rental expenses from that account, so each dollar can be followed from the line to its use. Mixing the draw with personal funds in a household checking account does not change the law, but it makes the allocation a reconstruction instead of a record, and reconstructions lose audits. If a draw was used partly for personal purposes, say so and allocate; the deductible portion survives.
Why this matters more now
Since the 2017 tax law, interest on a home equity line secured by a personal residence is deductible only when the money improves that residence, and only within an overall acquisition-debt limit. Investors sometimes assume the same restriction applies to a line on a rental. It does not: rental interest is business-type interest traced to the rental activity, deductible under the rental rules rather than the residence rules. That asymmetry is one reason a line on the rental, used for the rental, can be more tax-efficient than a line on your home used for the same purpose — a point worth raising with your accountant before you decide which property to borrow against.
What this page is not
Tax advice. Passive-activity limits, the at-risk rules, business-interest limitations and state law can all change the result for a particular investor, and only someone looking at your whole return can tell you how they apply. Take this page to that person.
- Treas. Reg. §1.163-8T, allocation of interest expense among expenditures (the "interest tracing" rule), and IRS Notice 89-35
- IRS Publication 527, Residential Rental Property — rental interest reported on Schedule E
Questions investors ask about this
Is interest on a HELOC secured by a rental deductible?
Generally yes, to the extent the draw was used for the rental or another rental or investment activity — the interest follows the use of the money under the tracing rule. Personal uses are not deductible even when a rental secures the line.
Does the $750,000 cap on mortgage interest apply?
That cap applies to interest on debt secured by a personal residence. Interest traced to a rental activity is reported as a rental expense on Schedule E and is not subject to the residence cap.
What if I use a HELOC on my own home to buy a rental?
Under tracing, that interest generally follows the money into the rental and is reported on Schedule E — not on Schedule A, since the money did not improve your residence. Keep records that show the path.
What records should I keep?
Put the draw in a dedicated account and pay rental costs from it, so each dollar is traceable. Keep the line statements, the closing statements for anything purchased, and invoices for improvements.
Do I need a CPA for this?
Yes. The tracing rule is the starting point; passive-activity, at-risk and business-interest rules can change the result. This page explains the mechanics so the conversation is a short one.
Keep reading
- How a HELOC on a rental worksWhat is different from the line on your own house, and why most banks say no.
- Using the line to buy the next rentalDown payment, closing costs, BRRRR and the refinance that follows.
- Rentals held in an LLCWhy title matters, what a deed change involves, and the alternative that lends to the LLC.
- HELOC vs. cash-out refinance on a rentalKeep the first mortgage you already have, or replace it.