Topic 03 · 5 min read
Debt and Leverage
Borrowed money is not income — and that is the whole point.
Real estate is one of the few assets ordinary people can buy largely with borrowed money. Loan proceeds are not taxable income, the interest is usually deductible, and refinancing can pull cash out of a property without triggering a sale.
What to know
- Loan proceeds are tax free
- Borrowing is not a sale, so taking a loan against a property does not create taxable income.
- Cash-out refinance
- Refinancing a property that has grown in value can return your original investment while you keep the building and its depreciation.
- Interest deductions
- Mortgage interest on investment property is generally deductible against rental income, subject to business interest limits for larger operations.
- Debt increases basis
- In a partnership, your share of the debt can raise the basis that determines how much loss you are allowed to deduct.
- At-risk rules
- Losses are limited to what you actually have at risk. Certain non-recourse borrowing is treated differently from money you personally guarantee.
The tax benefit
Access to cash without a taxable event, plus deductible interest that lowers the tax on rental income.
Worked example
Getting the down payment back
An investor puts $80,000 down on a duplex. Five years later the value has risen; a cash-out refinance returns the $80,000 tax free while the duplex keeps producing rent.
Watch out for
- Leverage multiplies losses as surely as gains.
- If a lender forgives debt, the forgiven amount can become taxable income.
- Bigger payments can turn a cash-flowing property into a negative one.
Terms from this topic
LeverageCash-out refinanceAt-risk rulesNon-recourse debt
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