Refinance rental to pay off residence?

lafdrMay 4, 2011

I have a rental property I have owned for 15 years. It is down to a balance of 12k. It has basically been breaking even or a slight cost every year. (Home value is under 200k) At the current rate it will be paid off in a year, so it will be mostly profit (minus expenses/tax/insurance). I can refinance and pull out about 150k at a new rate of 4 3/4. Payments will make me at a several hundred dollar loss between rent and mortgage which I can afford to cover.

My home mortgage has a balance of 150k. It is a 75k balance primary at 5.25% that we are paying off faster and should have done within 3yrs. And about 70k in a home equity loan at prime which has been running under 3% but does change with prime.

If we refi the rental, we can pay off the loans on our residence in full.

I am concerned if the rental is paid off and making income we just end up paying more income tax on the profit. But I am also trying to factor in losing the income tax deductions on our primary home if we pay off that loan so we only end up using the standard deductions.

If we pay off the primary, we would take the money we now pay the mortgage with and invest it in indexed mutual funds.

We were not thinking of taking the refi money and investing it in mutual funds, rather then paying off the loan. But maybe we should? Also should we not pay off the whole primary mortgage and consider a down payment on another rental property (near a large university with pretty steady tenant source)? Which would allow continued interest deductions.

My head starts spinning with the choices. We are in our 40s with solid income, yet still well below the 250k definition of "rich" We maximize our retirement accounts every year. 2 kids still going through school, with college to come.

Any thoughts on how to decide what to do? My ultimate goal is a paid for house and paid for rental, as well as maximized savings.

Should we just continue as we are going which will be a paid off rental and paid off home within 3 years? Or should we refinance and "move" some money around to somehow save on taxes and maximize savings?

Thanks for any outside perspective!

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I expect you're not in Canada, but I'd guess that the IRS and Canada Revenue Agency rules would be the same... that is, it is the purpose of the loan that determines if something is deductible. So if you increase the mortgage on the rental property, but use it to pay down your principal residence mortgage, you would NOT be able to claim the interest on the rental property mortgage. Check into IRS rules before deciding how to proceed.

    Bookmark   May 4, 2011 at 5:18PM
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I could never ever recommend that someone borrow money to put into the stock market. Never. My advice would be to pay off the rental property first, then turn what you would have paid on that loan on your principle residence. Or just accelerate the payments on your home, and put the extra into an account, be it no-load mutual funds or laddering bonds or CDs, depending on your comfort level. But why in the world would you borrow on either property when your goal is to own both properties free and clear?

    Bookmark   May 4, 2011 at 5:41PM
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Thank you for the comments.

The rental is almost paid off, so rent is going to become taxable as income soon. SO that made me wonder about taking money out of the rental equity to pay off the primary mortgage. The rent will pretty much pay the rental mortgage payments.

I am now paying 5k a month on my primary to pay it off asap. If I refi the rental and pay off the primary and home eq loans, tenant pays most of the loan. But I free up the 5k I am paying to the primary and home equity to invest.

The loans are all mostly interest at this point. Which is why the numbers might sound funny. The balances have gotten low since we are closer to payoff, but the payments are the same as they have been.

Does that help explain it better? I agree I would not refi to invest in mutual funds. But if mortgage is paid, it seems to free up more $ to invest on a slower basis.

Either way, I have about 150k in mortgage. The question: is there an advantage of the mortgage being on rental vs primary home?

Thanks for any more perspective!

    Bookmark   May 4, 2011 at 9:30PM
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And my point is: no, there is no advantage of the mortgage being on your rental vs. primary home. The only advantage there'd ever be is deductibility, which will not apply in this case. Or a lower interest rate on the primary home.

    Bookmark   May 4, 2011 at 9:34PM
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If you are on pace to have your rental and your home paid off within 3 years, don't change a thing. A positive (even taxable) income stream and no debt is a good thing.

    Bookmark   May 5, 2011 at 9:11AM
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Moving your home debt onto your rental just incurs refi expenses without any gain. In both cases you've got mortgage interest deductions. You should never opt for debt just because it's tax deductible. You'll pay $3-4 to the bank for every $1 you keep from sending the IRS. Keep going on your current track.

Keep it simple: Finish paying off your rental. Then take your rental income and add it to your extra mortgage payments. Then use the rental income plus your freed-up $5K/month and save like maniacs. At the rate you're going, you can pay cash for your next rental.

    Bookmark   May 5, 2011 at 10:19PM
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Please talk to your CPA tax accountant and/ or a lawyer specializing in this kind of situation. Much depends on both IRS rules and state laws.

    Bookmark   May 7, 2011 at 12:21PM
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My apologies ... I totally forgot about the mortgage interest deduction you guys have in the US. So my advice is worth about $0. :-)

    Bookmark   May 8, 2011 at 5:25PM
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The thing that would scare me is the $70K adjustable home equity loan. If there is only 2 or 3 yrs. left on it, it's not a big deal. If there is something like 10 yrs. then I would personally be concerned. Having lived through the years when mortgage interest rates were at 18% I tremble thinking about adjustable mortgages. A fixed rate mortage is the best deal in the world. If rates go way up, your rate can't be changed. If rates go way down you can refinance. The borrower has a much better deal than the lender in that regard. Of course that assumes the fixed rate is at a reasonable interest.

    Bookmark   May 12, 2011 at 11:25PM
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One of the biggest gain from the rental property is by properly structuring your taxes... You seem to have some grasp of that.

Rental income is not an active income. It is a passive income, even so it is taxed at your income tax rate. If there is a loss on your rental property, which most rental homes show because of the depreciation, you can actually deduct the loss from your income, if you meet the income eligibility, around 150k or less. It looks like you will not meet this requirement. This can be the place where the rental homes showing loss has the biggest taxable advantage. (I understand your question completely. I think others do not understand the tax portion of your question.) If you can create this situation of "passive loss", you can actually lessen your taxable income AND still have the mortgage deduction. It's a bit of double dipping, IMHO but this is how the tax code is written. I believe LLCs allow you to deduct the passive loss from your active income without the income eligibility. If you are interested, you should ask your tax attorney.

Interest you pay on a mortgage for a non-primary residence is about 1 to 2% higher than a mortgage for your primary residence, if you did not know this already. You need to do the numbers and see if the difference between the tax on the income from the rental house versus the higher/lower interest payment on your principle residence will show advantage one way or the other.

When you run out of depreciation on your rental home, you will see a huge jump in your taxable income from your rental. This really hurts... This is a good time to do a 1031 exchange to restart the depreciation clock. (look at your 1040 to see what you have for depreciation on your rental...)

I do my taxes with multiple rental properties and I have played around with the numbers to see where there is best tax advantage. I pay the top tax rate. So any tax deduction is "huge" to me.... This is easy with Turbotax. Even so, you need to see a tax professional. I have no professional credentials in taxes.

Good luck.

    Bookmark   July 20, 2011 at 6:40PM
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