HELOC on Investment Property: How the Interest Is Taxed

You pulled equity out of a property. Now your Form 1098 shows a year of interest. You want to know where it goes on your return.

Most people guess based on the house. A HELOC on investment property must be a rental deduction, they think. A HELOC on your home must be home mortgage interest, they think. Both guesses are often wrong.

The IRS uses a different test. It follows the money. This guide covers the tax side only. We do not give lending advice or talk about rates. Ask your lender about those.

#Start with the rule: interest follows the money

The rule lives in Treasury Regulation 1.163-8T. It sounds technical. The idea is simple.

#What the regulation says

The regulation says debt is allocated by tracing where the loan money went. Interest is then allocated the same way as the debt. One key line in the rule, paragraph (c)(1), says this: the allocation is not affected by which property secures the loan.

The IRS gives its own example. A person pledges stock as collateral for a loan. They use the money to buy a personal car. The interest is personal, even though investment property backs the loan.

#The five buckets

Under 1.163-8T, a dollar you spend can land in one of five main buckets:

• Trade or business: money spent in a business you run, like a Schedule C business.
• Passive activity: money spent in a passive activity. Most rentals are passive by default.
• Investment: money spent on investments, like stocks. The interest is investment interest.
• Personal: money spent on living costs, a car, a trip, or credit card payoffs.
• Portfolio: a narrow passive-loss category for property that makes portfolio income.

Where the interest goes on your return depends on the bucket, not the collateral.

#The one big exception: qualified residence interest

There is one carve-out. Under 1.163-8T(m)(3), qualified residence interest is deductible no matter how the tracing comes out. But since 2018, home equity debt only counts as qualified residence interest in one case. The money must be used to buy, build, or substantially improve the home that secures the loan. IRS Publication 936 says that plainly.

The One Big Beautiful Bill Act, signed July 4, 2025, removed the 2025 end date. So that limit is now permanent, under Section 163(h)(3)(F). The law also sets a $750,000 cap on qualified home debt ($375,000 if married filing separately). Those dollar figures are set in the statute and do not change with inflation. So for a HELOC used on a rental, this exception almost never applies. Tracing decides instead.

#Use a HELOC on your home to buy a rental

This is the most common setup. You borrow against your main home to pay a down payment or the full price of a rental.

#Where the interest goes

The money did not buy, build, or improve your home. So the interest is not qualified residence interest. You cannot deduct it on Schedule A as home mortgage interest.

But tracing says the money went into a rental. So the interest is a rental expense. IRS Publication 936, Table 2, points interest “incurred to produce rents” to Schedule E. Publication 936 also says this. Did you use mortgage proceeds for business, investment, or other deductible activities? Then that part of the interest can be deducted there, subject to the limits that apply.

#Which line on Schedule E

The Schedule E instructions put interest on a mortgage on the rental on line 12, when you paid a bank. Interest that does not fit there goes on line 13, Other interest. The IRS instructions do not say which line to use for this case. Our reading is line 13. The loan is a mortgage on your home, not on the rental. Keep records that show the loan money went to the rental. Your Form 1098 will list your home’s address, so keep a note explaining the difference. Our Schedule E walkthrough covers each line.

#The passive loss catch

Rental interest is a rental expense, like any other. It can push the rental into a loss. That loss may be limited by the passive activity rules. Is your income too high for the special allowance? Then the interest still counts, but part of the loss may carry forward. See our guide to passive activity loss rules.

#Draw on a rental property equity line of credit

Now flip it. You have an equity line of credit on a rental property, and you draw on it.

#Money spent on the same rental or another rental

If you spend it on that rental, like a new roof, the interest is rental interest on Schedule E for that property. If you spend it on a different rental, tracing puts the interest with the rental that got the money.

#Money spent on personal costs

If you draw on the rental’s line to pay for a family vacation, a car, or a credit card, the interest is personal interest. Under Section 163(h), personal interest is generally not deductible.

Pub. 527 says the same about points on a cash-out refinance of a rental. Points tied to money you did not use for the rental generally cannot be deducted as a rental expense. Here’s its example: a rental loan refinanced from $100,000 to $120,000, with the extra $20,000 used to buy a car. The points on that $20,000 are nondeductible personal interest.

#Money spent on your own home

Here is a trap. Say you draw on a rental’s line of credit to remodel the kitchen in your main home. It feels like a home improvement. But the loan is not secured by your main home, so it is not qualified residence interest. Under tracing, it is a personal expense. Our reading, so confirm it before you rely on it: that interest is generally not deductible anywhere.

Read across each row. The use of the money sets the tax treatment. The collateral mostly changes which line or form you use.

#Split the interest when one line pays for mixed uses

A HELOC is a revolving line. People draw, repay, and draw again, often for different things. Tracing still works. It just takes more steps.

#Allocate by use

Each draw is traced to what it paid for. Interest is split in the same ratio as the debt balance allocated to each use during the year.

#A worked example that adds up

Say you open a HELOC on your home. In January you draw $60,000:

• $50,000 is wired straight to the title company as the down payment on a rental
• $10,000 pays off your car loan

You make no other draws or payments. The balance stays at $60,000 all year, and your Form 1098 shows $4,200 of interest.

• Rental share: $50,000 divided by $60,000 = 5/6
• Rental interest: $4,200 times 5/6 = $3,500 (Schedule E)
• Personal share: $10,000 divided by $60,000 = 1/6
• Personal interest: $4,200 times 1/6 = $700 (not deductible)
• Check: $3,500 plus $700 = $4,200

#Which part is paid off first

Now say you pay down $10,000 the next January. Which use did you pay off? Treasury Regulation 1.163-8T(d)(1) answers with a fixed order. Debt is treated as repaid in this order:

1. Personal uses
2. Investment and passive uses (other than item 3)
3. Rental real estate where you actively participate
4. Former passive activities
5. Trade or business uses

So your $10,000 payment wipes out the personal part first. From then on, the whole $50,000 left is traced to the rental. All the interest becomes rental interest. That order works in your favor. The rule is built to pay down the personal part of a mixed line first.

#Line of credit details

Paragraph (d)(3) says that on a line of credit, all draws that carry the same rate are treated as one debt. Draws at different rates are treated as separate debts. This is a detail your preparer will want to know if you have a fixed-rate lock on part of the line.

#Know the timing rules for deposits and cash

Tracing is easy when the lender pays the seller directly. It gets harder when the money passes through your checking account.

#Paid straight to a third party

Under 1.163-8T(c)(3), the lender might send the money directly to someone else, like a title company or contractor. Then you are treated as using the money for that purpose. This is the cleanest trail you can have.

#Deposited in your account

If the money lands in your bank account first, the regulation treats it as an investment until you spend it. When you spend from that account, borrowed money is generally treated as spent first. Money already in the account, or added later, counts as spent after that.

There is also a 15-day rule in paragraph (c)(4)(iii)(B). You may treat any payment made from the account within 15 days after the loan money was deposited as paid from that loan money. IRS Notice 89-35 widened this to 30 days before or after the deposit, for payments from any of your accounts or from cash. IRS Publication 550 states the 30-day rule. That gives you room to line up a rental payment with the draw.

#Taken out in cash

Cash is the weakest trail. Under paragraph (c)(5), cash you spend within 15 days can be treated as from the loan. Notice 89-35 widens that window to 30 days before or after you get the cash. Otherwise, loan money you take as cash is treated as used for personal purposes. Do not take a rental draw in cash.

#Keep the records that prove the deduction

The Schedule E instructions say that, in most cases, you must have records showing how the proceeds of each debt were used. That is the whole case for your deduction.

#What to keep

• Draw records from the lender for every advance, with dates and amounts.
• Wire or check proof showing where each draw went, like the closing statement or contractor invoice.
• Bank statements for the account the money passed through.
• Annual Form 1098, plus a short note showing how you split the interest.
• Repayment history, so you can apply the ordering rule each year.

#A simple tracing log

Keep a one-page log for each line of credit: date, amount drawn or repaid, what it paid for, and which bucket. Your lender sends one Form 1098 with the total, so this log is how you split it.

This is the kind of thing clean monthly books handle for you. Our bookkeeping service can track loan draws by property so the interest split is ready when your return is.

#Watch the entity

Is the rental owned by an LLC or another entity? Then tracing still applies. But the loan, the property, and the reporting should all line up. A personal HELOC used for an LLC’s rental adds a step. See our guide on rental property in an LLC vs. your personal name.

#Check the special cases before you file

A few edge cases change the answer.

#When the rental is a business

Rental interest is generally not subject to the business interest limit under Section 163(j). The one exception is when the rental activity counts as a trade or business, per the Schedule E instructions. If it does, you may need Form 8990, and some interest can carry forward.

#The election to treat a loan as unsecured

Treasury Regulation 1.163-10T(o)(5) lets you elect to treat a debt secured by your home as not secured by it. IRS Publication 936 explains that some people use it when the interest is fully deductible some other way, such as a business expense. Once you make this election, it stays in place for later years. You can only revoke it with IRS consent. This is a fact-specific call, so talk it through before you use it.

#Texas notes

Texas has no state income tax, so for San Antonio investors this is a federal-only question. Texas does have its own home equity lending rules in the state constitution. Those are a lending question, not a tax one, so ask your lender.

For a look at the other 2025 law changes that touch rentals, see our OBBBA real estate summary.

#Common questions

#Is HELOC interest on an investment property tax deductible?

Usually yes, if you spend the money on the rental. Then it’s a rental expense on Schedule E. Do you spend it on personal things instead? Then the interest is personal, and generally not deductible, even though a rental secures the loan.

#Can I use a HELOC on my house to buy a rental and deduct the interest?

Generally yes, but not as home mortgage interest on Schedule A. The money went into the rental, so tracing makes it rental interest, reported on Schedule E. The rental’s loss may then be limited by the passive loss rules.

#Does it matter which property secures the HELOC?

Not for deciding whether interest is deductible. Treasury Regulation 1.163-8T says the allocation is not affected by the collateral. The collateral mostly affects which line or form you use.

#What if I used my HELOC for a rental and for personal stuff?

Split the interest based on how much of the balance went to each use. Personal debt gets treated as paid off first. So paying down the line shifts more of the remaining interest to the rental over time.

#Can I deduct interest on a rental HELOC used to pay off credit cards?

No. Credit card payoff is a personal use, so the interest is personal interest. It does not matter that a rental secures the line.

#Does the $750,000 limit apply to a HELOC used for a rental?

No. That limit is for qualified residence interest on your main or second home. HELOC interest traced to a rental is rental interest, so the $750,000 cap does not apply to it.

#What happens if I cannot prove where the money went?

You may lose the deduction. The Schedule E instructions say you generally need records showing how each loan’s money was used. Without them, the IRS can treat the interest as personal.

#Ready to talk through your situation?

The right setup depends on how you draw, how you repay, and how your rentals are owned. We help investors plan these moves through our tax planning service before the money moves, not after.

Book a Tax Discovery call: free, on Google Meet, no pitch, free advice either way.