Is Interest on a Rental Property's Second Mortgage Tax Deductible?

Interest on a second mortgage can be deductible, but the IRS looks at what you spent the money on, not at which property secures the loan. Money spent on a rental can produce a rental expense. Money spent on something personal generally does not. This guide walks through the IRS sources. It is general information, not tax advice, and your CPA decides how it applies to your return.

What the IRS says about rental mortgage interest

IRS Publication 527, Residential Rental Property (2025 edition), says: "You can deduct mortgage interest you pay on your rental property." Rental income and expenses are reported on Schedule E (Form 1040), according to the same publication (IRS Pub. 527, accessed 2026-10-07).

The same paragraph adds a limit. When you refinance a rental for more than the old balance, the portion of the interest tied to proceeds "not related to rental use" generally can't be deducted as a rental expense. That sentence is about a refinance, but it shows the principle the rest of this guide turns on: the use of the money matters.

Interest follows the use of the money

The rule that sets the allocation is Treasury Regulation 1.163-8T. It says debt is allocated "by tracing disbursements of the debt proceeds to specific expenditures," and that debt is allocated "in accordance with the use of the debt proceeds" (26 CFR 1.163-8T(a)(3) and (c)(1), accessed 2026-10-07).

The IRS explains it in plain terms in Publication 535, the business expenses guide. The 2022 edition is the final revision; the IRS no longer updates it. It says you allocate interest on a loan "the same way you allocate the loan proceeds," and that "the allocation of loan proceeds and the related interest is generally not affected by the use of property that secures the loan" (IRS Pub. 535 (2022), chapter 4, Allocation of Interest, accessed 2026-10-07).

For a second mortgage on a rental, that means the lien sits on one property and the interest goes where the dollars went. The Publication 535 categories are nonpassive business, passive business, investment, portfolio and personal interest. Rental activity is generally subject to the passive activity limits that Publication 527 discusses, and your CPA will tell you which bucket each dollar belongs in.

Three common uses of the cash

• Improving or maintaining the same rental. The proceeds go back into the property that secures the loan, so the interest relates to rental use. Publication 527 lists mortgage interest on a rental as a deductible rental expense.
• Buying or improving a different rental. The lien is on rental A, but the money is used on rental B. Under the tracing rule, the interest follows the use, so it relates to rental B. The rule is tracing, so records that show where the money went matter. Ask your CPA what to keep. Interest on a property that is not yet rented or available for rent may not be a rental expense yet. Ask your CPA how to treat it.
• Spending it on something personal. The part of the proceeds used for personal purposes produces personal interest, which is not a rental expense. Publication 527 gives an example for points on a refinance: a $100,000 balance is refinanced into a new $120,000 loan, and the extra $20,000 buys a car. The points allocable to the $20,000 are treated as nondeductible personal interest. Interest follows the same logic.

USA Mortgage lends for business purpose only. A loan being business-purpose for lending rules does not decide how the IRS treats your interest. The two questions are separate.

Mixed use, and keeping the money traceable

If you use one loan for more than one purpose, the IRS says you "must allocate the interest based on the use of the loan's proceeds." Publication 535 gives an example of a $100,000 loan deposited in a checking account. Part of it goes to a passive activity, part to personal use, and the interest is split by period and by use.

Publication 535 also has a practical tip. The easiest way to trace disbursements is to keep the proceeds of a particular loan separate from any other funds. It also says loan proceeds deposited in an account are generally treated as spent before other money in the same account. If you plan to use a second for both a rental and something else, ask your CPA how to set up the accounts before the money lands.

Points and closing costs

Publication 527 says points are the charges a borrower pays to take out a loan, and that points solely for the use of money are interest. "Because points are prepaid interest, you generally can't deduct the full amount in the year paid, but must deduct the interest over the term of the loan." If the loan ends early, you may be able to deduct any remaining points in the year it ends. A refinance with the same lender is an exception (IRS Pub. 527, Points, accessed 2026-10-07).

The same publication says certain expenses of getting a mortgage on a rental, such as mortgage commissions, abstract fees and recording fees, can't be deducted as interest. It describes them as capital expenses that are part of your basis in the property.

Other limits that can apply to rentals

Publication 527 also covers limits on rental losses, including at-risk rules and passive activity limits reported on Form 8582. A deductible interest payment can still run into those limits in a year when the property shows a loss. Your CPA can tell you whether they apply to you.

Where USA Mortgage fits

Our second mortgage program is a business-purpose loan on non-owner-occupied investment property. Typical terms, subject to underwriting: $50,000 to $1,000,000, as a lump sum or a line of credit, first or second lien, a fixed rate from 6.99%, 660 minimum FICO, up to 80% CLTV on investment properties, 3-4 week close. Read how a second mortgage on a rental works, run the numbers in the second mortgage calculator, and compare it with a cash-out refinance.

This page is general information, not tax or legal advice, and we are not tax advisors. Whether and how much interest you can deduct depends on your facts. Talk to a CPA or tax professional before you borrow. Business-purpose lending only. Not a commitment to lend. Terms shown are typical and subject to underwriting.