Why cash out property before changed to rental use?

by Joe Gokaho 2010.02.12 D5

I am thinking about buying another property and converting existing primary home into a rental property. An accountant suggests to "cash out" as much as possible and use that as the down payment toward the new house. But why?

Why shifting the mortgage from your primary residence toward the rental property when interests in either "rental" and "primary residence" can be deducted from the tax returns.

As a rental property (Schedule E)

The Supplemental Income and Loss = rental income -expenses - interests - property tax -depreciation;

As a primary residence,

The interests, property tax are both deductible from the gross income.

# # #

When interest payment is deducted from Schedule E, the supplement income is added to AGI, when interest payment is deduct from Schedule A, AGI is also reduced.

So, it appears it doesn't affect the bottom line when determining taxes, right?

Well,

Many tax incentives are based on Adjusted Gross Income, the tax payment is based on (AGI - deductions). By shifting interests payment away from "Schedule A" to "Schedule E", you may qualify even more deductions. For example -the medical, educational deduction are based on AGI, if you have a lot of rental income, you may loose that deductions.

On the other hand, if you have losses on the rental property, you can only write off up to $25,000 a year. If your AGI is more than 150,000/yr - only part of the loss can be deducted. When I buy the 2nd, or 3rd or that vacation home -- it will be an interesting balancing act to avoid paying more taxes than you have to!