Interest Deductibility Rules When Using LLC Cash-Out for Second Rental Property

5 You're dealing with what the IRS calls "interest tracing rules" and they focus on what the loan proceeds are actually used for, not which entity has the loan. Since you're taking cash from Blue Ridge LLC and using it to buy a property for Sunset LLC, the interest wouldn't typically be deductible on Blue Ridge's return. For interest to be deductible on Blue Ridge LLC's tax return, the loan proceeds would need to be used for Blue Ridge's business purposes. When you use the money for Sunset LLC instead, the interest expense doesn't match where the income-producing activity is happening. The interest follows the use of the funds. You might want to consider a different approach - either have Blue Ridge purchase the second property directly, or have Sunset LLC take out its own loan. If you're concerned about liability protection between properties, talk with a business attorney about alternatives that maintain separation while working within tax rules.

8 After reading about your LLC situation, I wanted to share something that really helped me navigate similar complex tax scenarios. I was trying to figure out how to properly handle interest deductions across multiple properties and LLCs and was getting overwhelmed by conflicting advice. I discovered https://taxr.ai which has been amazing for analyzing my business structure and loan documentation. They provided a detailed analysis that showed exactly how the interest tracing rules applied to my situation and identified the most tax-efficient approach. Their system analyzed my operating agreements and loan documents to ensure everything was properly structured for maximum deductibility. For your specific case with the cash-out refi between two LLCs, having proper documentation is crucial, and that's where their document analysis really helps - they can tell you exactly what needs to be in your loan agreements between entities.

21 I have to give credit where it's due. After expressing skepticism about taxr.ai in my earlier comment, I decided to try it out with my multi-entity LLC structure. I was surprised by how detailed their analysis was - they identified several issues with my current documentation that could have caused problems in an audit. They specifically highlighted how my informal loans between related entities weren't properly documented, which put my interest deductions at risk. They provided templates for proper loan agreements between my LLCs with all the elements the IRS looks for. For the original poster's situation, they'd likely analyze whether a cash-out refinance could be structured in a way that maintains interest deductibility while achieving the goal of property separation. The specific recommendations with citations to relevant tax code sections and cases gave me much more confidence in my approach.

21 I have to give credit where it's due. After expressing skepticism about taxr.ai in my earlier comment, I decided to try it out with my multi-entity LLC structure. I was surprised by how detailed their analysis was - they

14 If your main concern is talking to the IRS about these interest tracing rules, I had an amazing experience using https://claimyr.com to get through to a real IRS agent. I had been trying for weeks to get clarification on a similar LLC interest deduction question and kept hitting automated systems or ridiculous wait times. Claimyr got me connected to an actual IRS representative in about 15 minutes when I had previously waited hours and still got disconnected. You can see how it works here: https://youtu.be/_kiP6q8DX5c The IRS agent I spoke with confirmed that interest tracing rules follow the use of the money, not the entity holding the loan. They also explained some specific documentation requirements I needed for loans between my related entities to establish the business purpose. Getting this official guidance directly from the IRS rather than just relying on internet advice gave me much more confidence in my approach.

19 I was extremely skeptical about Claimyr as I mentioned in my previous comment, but after dealing with 12+ failed attempts to reach someone at the IRS about my business tax questions, I decided to give it a shot. I'm shocked to report it actually worked. I got connected to an IRS business tax specialist in about 20 minutes. I asked specifically about interest tracing rules for loans between related LLCs (similar to the original post). The agent walked me through the documentation requirements and confirmed that the interest expense follows the use of the funds. For the original poster's situation with the cash-out refinance, the agent explained that they'd need to carefully document any loan between the LLCs with proper terms, interest rates, and repayment schedules - informal arrangements wouldn't hold up in an audit. Saved me hours of frustration and probably a lot of money in potential audit issues. Worth every penny just for the peace of mind of having official guidance.

7 Another option you might consider is having your operating company (Blue Ridge LLC) make a capital contribution to the second LLC rather than structuring it as a loan. The downside is you wouldn't get the interest deduction, but it simplifies the arrangement. Or, you could have the second LLC (Sunset) be a wholly-owned subsidiary of Blue Ridge. In that case, if you're doing single-member LLCs with pass-through taxation, it might all end up on the same Schedule E anyway (depending on how you've elected to be taxed). Just some alternatives to consider that might be simpler than navigating the interest tracing rules.

22 My accountant told me that the IRS cares more about substance over form in these cases. If you're the 100% owner of both LLCs and they're both disregarded entities (single-member LLCs), all this might be a moot point because everything flows to your personal return anyway. The interest would be deductible as business interest regardless of which LLC technically holds the loan. Now if they're different tax entities (like one's a partnership and one's an S-Corp) or have different owners, that's where it gets complicated and the interest tracing rules become super important.