The tax-deduction rules for rental homes are completely different than the rules for your own home. You can usually deduct the interest on a home equity line of credit taken against a rental home, relative to that rental home's income. However, calculating how that deduction affects your overall taxes can be more complicated.
General Deduction Rules
Generally, the Internal Revenue Service allows you to write off, in their words, any "ordinary and necessary expenses" that you incur in owning your rental property. This includes not only your property taxes and mortgage interest, but also HELOC interest, utilities, repairs, and even the cost of management, insurance and depreciation. Individual taxpayers and small investors generally report their rental property income and expenses on the Schedule E form.
While the IRS doesn't cap the amount of interest you can write off on your rental properties, it does prevent you from deducting interest of a personal nature. For instance, if you were to take out a HELOC against your rental property to pay off your personal credit cards, that interest wouldn't be deductible. A HELOC that you take out to provide down payment funds for another property would be, however.
In addition, some interest expenses relative to the cost of developing new rental real estate also may need to be treated specially. If you're borrowing money to build a new rental property, some of that interest might need to be capitalized while you're preparing it for use. An accountant's guidance may be helpful in these situations.
Schedule E Losses
On the Schedule E form, you report all of your income and all of your expenses. At the bottom of the form, calculate your profits and losses on a per-property basis and then on an overall basis. For instance, if you only have one rental home on which you collect $12,000 in rent and pay $11,500 in expenses including your interest, you'd have a $500 profit. If you have two rental homes and make $500 on one but lose $200 on the other, you'd only have a $300 profit. In either case, you carry your profit over to your 1040 tax return, where it gets added into your overall income.
Losses and Your Income
Sometimes, if you have high expenses from a HELOC or other sources, you might end up with a loss from your rental property or properties. The IRS may let you take that loss as a deduction against your regular income if you meet a few requirements. First, you need to be actively involved in managing your properties, Second, you have to have a modified adjusted gross income of $100,000 or less -- the loss allowance gets reduced by $1 for every $2 of income above that threshold. Third, you can only write off up to $25,000 of losses per year. Any losses in excess of that amount or losses incurred when your income is over the threshold get carried forward for use in the future to offset other rental property gains or, if your income allows it, other income.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.