Can I deduct the interest if I used the cash-out money to buy my primary residence?

No. Acquisition debt under §163(h)(3)(B) must be secured by the residence it buys, and a cash-out loan is secured by the rental. The tracing rules then allocate those dollars to a personal expenditure, so the interest on that slice is nondeductible personal interest under §163(h)(1). If you want deductible interest on a home purchase, the mortgage has to sit on the home itself.

Will the IRS actually check what I did with cash-out refinance money?

On a Schedule E exam, yes, and quickly. The Form 1098 tells the agent the total interest; the loan file tells them the balance jumped at the refinance; the first information request asks where the difference went. The substantiation burden is yours under §1.163-8T, so an interest deduction you can't trace with bank statements and the closing disclosure is an interest deduction you lose.

What if I already deposited the proceeds into my regular checking account?

You have a window. Notice 89-35 lets you treat any expenditure made within 30 days before or after the deposit, from any account, as made from the loan proceeds. Outside that window, the ordering rules of §1.163-8T(c)(4) treat spending from the commingled account as coming from loan proceeds first, whatever the spending was. Move the remaining proceeds to a clean account now and document what's already gone out.

Is a HELOC on a rental property treated the same way?

Yes. The tracing rules apply to any debt, so a HELOC drawn against a rental is deductible only where each draw went. The reverse also works: a HELOC on your own home spent on a rental generally deducts on Schedule E, because post-2017 law denies it qualified residence treatment and tracing then allocates it to the rental activity. Collateral location changes the paperwork, not the answer.

Can I pull cash out of a rental, buy stocks, and still deduct the interest?

Partly. Dollars traced to a taxable brokerage account produce investment interest expense under §163(d), which is deductible on Form 4952 only up to your net investment income for the year, mostly interest, nonqualified dividends, and short-term gains. Anything disallowed carries forward indefinitely. It's a real deduction, just slower and capped, and it requires itemizing.

The Journal / Real Estate Tax

Is the Interest on a Cash-Out Refinance of a Rental Property Deductible? Only Where the Money Went.

By Ewan Morkel, EAJuly 15, 20266 min read

A landlord pulls $180,000 out of a duplex and the lender calls the whole payment deductible. The tracing rules of Treas. Reg. §1.163-8T disagree. Where each dollar has to go, and the $5,400 mistake in one worked refi.

A Provo landlord refinances a duplex that has nearly doubled in value, walks away from closing with $180,000 in cash, and asks the question every loan officer waves off: is the interest on a cash-out refinance of a rental property tax deductible? The lender says yes, it's a rental loan. The Form 1098 will report one interest number in January as if that settled it. Neither the lender nor the 1098 decides. Treas. Reg. §1.163-8T decides, and it doesn't care which building secures the note. It follows each dollar of proceeds to whatever that dollar bought.

The tracing rule

Why the collateral doesn't decide whether a cash-out refinance on a rental is deductible.

The rule is Treas. Reg. §1.163-8T, written in 1987, still labeled temporary, and fully in force. Debt is allocated by tracing the disbursement of its proceeds to specific expenditures, and the interest follows the debt. The property pledged as collateral is irrelevant to the analysis. A loan secured by a rental and spent on a boat is boat debt. A loan secured by your house and spent on a rental is, with one wrinkle covered in the FAQs below, rental debt.

The refinance itself is safe. Under §1.163-8T(e)(1), replacement debt is allocated exactly the way the debt it repaid was allocated, so the portion of the new loan that retired the old purchase mortgage stays on Schedule E without any further work. The tracing question is only about the cash-out slice. And nothing on the Form 1098 does this work for you: the bank reports every dollar of interest in one box, and you are the one who has to claim less than the box shows.

Four buckets

Where each cash-out dollar can land, and what each landing pays.

Back into the same rental (a roof, a kitchen, the payoff itself): deductible on that property's Schedule E, no limit.
Into another rental, as a down payment or improvements: deductible, but on the new property's Schedule E, subject to that activity's own passive loss rules under §469.
Into taxable investments like a brokerage account: investment interest under §163(d), deductible on Form 4952 only up to your net investment income, with the excess carried forward.
Into anything personal (cars, credit cards, a wedding, your own home): personal interest under §163(h)(1), deductible nowhere, for as long as that slice of the loan exists.

The fourth bucket hides the harshest version of the trap: spending rental cash-out money on your own home. Improving a primary residence feels like the responsible use, but acquisition debt under §163(h)(3)(B) must be secured by the residence it buys or improves, and this loan is secured by the duplex. So the interest fails the qualified residence rules and fails tracing at the same time. The 2025 One Big Beautiful Bill Act made this permanent by locking in both the $750,000 acquisition debt cap and the disallowance of home equity interest, so there is no sunset to wait out.

A $400,000 refi on a Provo duplex, $180,000 pulled out, tax year 2026.

New loan at 6.75%; first-year interest: $27,000
Payoff of old duplex mortgage: $220,000 (55%): $14,850 to Schedule E
Down payment on a second rental: $100,000 (25%): $6,750 to new Schedule E
Kitchen remodel on their own home: $50,000 (12.5%): $3,375 nondeductible
Car loan and credit card payoff: $30,000 (7.5%): $2,025 nondeductible
Interest deductible across both rentals: $21,600
Nondeductible personal interest, every year: $5,400

Tax year 2026. First-year interest approximated as 6.75% on the full $400,000 balance; on an amortizing note the dollar amounts shrink but the percentage split holds. Assumes the proceeds stayed traceable under Notice 89-35. The $220,000 payoff slice keeps its old allocation under §1.163-8T(e)(1).

That $5,400 is not a one-time haircut. It recurs every year until the personal slice of the loan is paid down, and at a 32% federal rate plus Utah's 4.45%, deducting it wrongly on Schedule E overstates the benefit by about $1,970 a year. This same tracing logic runs underneath the buy, borrow, die strategy, and it's the thing that makes bucket two work: pulling equity to fund the next down payment is how high-W-2 landlords scale a portfolio without the interest deduction leaking.

Keeping it clean

The separate account that saves the deduction.

Tracing is a records game, and the IRS wrote the playbook in Notice 89-35: an expenditure made within 30 days before or 30 days after the proceeds hit any of your accounts can be treated as made from those proceeds. Miss that window with the money sitting in your everyday checking account and the ordering rules of §1.163-8T(c)(4) take over, treating whatever you happened to buy next as bought with loan money, groceries included. The fix costs nothing: open a fresh account, wire the cash-out proceeds into it at closing, and pay the roof contractor or the second property's escrow directly from that account. Keep the closing disclosure and the statements. Ten minutes of banking hygiene is the difference between a deduction you can prove and one you concede on exam.

One housekeeping item while you're at it: the points and loan costs on a rental refinance are not deductible at closing. They amortize over the life of the new loan, and they get split across the same four buckets as the interest.