Rental mortgage interest: deductions, points and refinance rules

By Tom, CPA · Updated October 27, 2026

Part of: Rental Property Taxes

TL;DR: Interest on a loan used to buy or improve a rental is a Schedule E expense, without the home mortgage interest caps. Points on a rental loan are amortized over the loan term, not deducted up front. After a cash-out refinance, interest follows the use of the money under the tracing rules, so the share spent on personal items is not a rental expense. Most small landlords are exempt from the section 163(j) limit.

Educational only, not tax, legal, or investment advice. Examples are illustrations, not predictions. Rules and limits change; verify current figures and talk to a qualified professional about your situation.

Your tenant pays the mortgage; the IRS pays for the roof (eventually, over 27.5 years). Better yet, the IRS lets you deduct the interest part of that mortgage, in full, against the rent. That is one of the cleanest landlord deductions in the code, and it gets messy only when points, refinancing or very large portfolios enter the picture.

Rental mortgage interest is deducted under section 163 and section 212 as an expense of producing rental income, reported on Schedule E. It is not subject to the home mortgage interest rules on Schedule A (the acquisition debt caps and the second-home limits), because it is not qualified residence interest. For the personal-residence side, see the mortgage interest deduction guide.

CPA Warning Label: Refinancing the rental to buy a boat turns the boat interest into a personal expense. The bank does not care what you bought. The tracing rules do.

Fully deductible on Schedule E

IRS Publication 527 lists mortgage interest on rental property as a deductible rental expense. Key points:

• Form 1098. If you paid $600 or more of mortgage interest on the rental to one lender, you should receive Form 1098. Interest paid to banks goes on Schedule E line 12; other interest (seller financing, private lenders) on line 13.
• Co-borrowers. If you and someone other than your spouse were both liable and paid the interest, and the other person received the Form 1098, Publication 527 says to report your share on line 13 and attach a statement explaining it.
• Escrow is not interest. Your monthly payment includes principal, interest and often escrow for taxes and insurance. Only the interest portion is interest; escrowed taxes and insurance are deducted on their own lines when the lender pays them. Principal is never deductible.
• No caps. The $750,000 acquisition debt limit for home mortgages does not apply. A $2 million apartment loan's interest is deductible in full, subject to the passive activity rules and, for large businesses, section 163(j).
• Prepaid interest is generally deductible over the period it covers, not when paid, even for cash-method taxpayers.

Interest is part of the passive activity's results. If the rental produces a net loss, the interest is part of that loss and is subject to the passive loss limits; see rental losses and W-2 income.

Points amortization

Points (also called loan origination fees, maximum loan charges or premium charges) that are solely for the use of money are interest. Publication 527 explains that because points are prepaid interest, you generally cannot deduct the full amount in the year paid on a rental loan; you deduct them over the term of the loan.

• Method. Points are amortized under the original issue discount rules. For many small loans, the de minimis OID rule lets you spread them ratably (straight-line) over the loan term. Otherwise the constant-yield method applies. Publication 527 walks through both.
• Not like your home. The rule that lets you deduct points on a loan to buy your main home in the year paid does not apply to rentals.
• Other closing costs to get the loan, such as mortgage commissions, abstract fees and recording fees, are not interest; Publication 527 calls them capital expenses. See amortizing loan fees for how to recover them.
• Loan ends early. If you pay off or refinance the loan with a different lender, you can generally deduct the remaining unamortized points in that year. If you refinance with the same lender, Publication 527 says the remaining balance is generally deducted over the term of the new loan.

Refinance rules

Refinancing does not change the character of interest by itself. What matters is how the borrowed money is used, under the interest tracing rules of Temp. Reg. 1.163-8T.

• Rate-and-term refinance that replaces the old rental loan: interest stays a rental expense.
• Cash-out refinance: the portion of the new loan that pays off the old rental debt keeps its rental character. The extra cash is traced to whatever you spend it on. Publication 527 notes that when you refinance a rental for more than the previous outstanding balance, interest allocable to proceeds not related to rental use generally cannot be deducted as a rental expense.
• Spent on another rental: rental interest for that property.
• Spent on stocks: investment interest, deductible on Schedule A subject to the investment interest limit (Form 4952).
• Spent on a car, vacation or personal debt: personal interest, not deductible.
• Spent on a business: business interest on Schedule C or the business return.
• Tracing records. Keep the cash in a separate account until spent, or spend it within 30 days. The regulations allow you to treat spending within 30 days of the deposit as made from the loan proceeds.

Using home equity to buy a rental

The reverse works too. If you borrow against your personal residence and use the money to buy or improve a rental, the interest traced to the rental can be deducted on Schedule E as rental interest, even though the loan is secured by your home. You need records showing the trace.

Business interest limit (163j) exemptions

Section 163(j) limits the deduction for business interest of a trade or business to the sum of business interest income plus 30% of adjusted taxable income (and floor plan interest). Most small landlords are not affected, for several reasons:

• Small business exemption. Taxpayers that meet the gross receipts test of section 448(c) are exempt. For tax years beginning in 2026, the threshold is average annual gross receipts of $32,000,000 or less for the prior three years, per Rev. Proc. 2025-32. Aggregation rules apply to related entities, and tax shelters cannot use the exemption.
• Not a trade or business. Section 163(j) applies to business interest. A rental that is an investment rather than a trade or business is outside it, though other limits may apply.
• Electing real property trade or business. A larger real estate business can elect out of 163(j). The price: it must use the alternative depreciation system (ADS) for residential rental property, nonresidential real property and qualified improvement property, which means longer lives and no bonus depreciation on those assets. The election is irrevocable.

If you are anywhere near the gross receipts threshold, the election analysis deserves professional modeling. For everyone else, 163(j) is a footnote.

Example

Illustration: Larry owns a fourplex with a $400,000 loan at 6.5%. In March 2026 he does a cash-out refinance with a new lender: a $550,000 loan at 6.25% for 30 years, paying $6,000 of points. He uses $400,000 to pay off the old loan, $100,000 for a down payment on a second rental, and $50,000 for a kitchen remodel at his personal home. Assumptions: interest computed simply on balances for illustration; first-year interest on the new loan is about $27,000 for the remaining months of 2026; the old loan had $1,500 of unamortized points.

• Allocation by use: $400,000 / $550,000 = 72.7% to the fourplex; $100,000 / $550,000 = 18.2% to the new rental; $50,000 / $550,000 = 9.1% personal.
• Interest: fourplex about $19,630; new rental about $4,910; personal about $2,460, which is not deductible as rental interest. (It may or may not be deductible as home mortgage interest; the loan is not secured by the personal home, so it generally is not.)
• Points: $6,000 over 360 months is about $16.67 a month. For 9 months of 2026, about $150, allocated the same way; the personal share is not deductible.
• Old loan points: because the refinance was with a different lender, the remaining $1,500 is deductible in 2026 on the fourplex.

Takeaway: the same loan produces three different kinds of interest. If Larry had used a home equity loan on his house for the kitchen and kept the rental refinance to $500,000, all of the rental loan interest would be rental interest. See also paying down the rental mortgage versus depreciation.