Category: CPA Partners

Short answer: a gift and a family loan are not two flavors of the same thing. A properly documented gift can be used for a down payment and does not count against the borrower’s debt ratios. A loan from a parent generally cannot be used as down payment funds at all, and if it exists it has to be disclosed and counted. The tax treatment runs the opposite direction, which is why this decision belongs on a CPA’s desk before it lands on mine.

Who this is for

This one is written for the CPAs, enrolled agents and financial planners I work with in San Diego whose clients are quietly funding their kids’ first purchase. It comes up every fall, and it came up twice last week. The parents have the money. They want to help. Nobody has asked whether the help should be structured as a gift or a note, and by the time it reaches me the money has usually already moved.

That is the expensive part. Once the funds are in the buyer’s account with no paper behind them, the options narrow fast.

The timing question your clients are actually asking right now

Freddie Mac’s Primary Mortgage Market Survey put the 30-year fixed national average at 6.95% on September 17, 2026 — up from 6.76% the week before, and up from 6.26% a year ago. That is a 19-basis-point move in a single week.

Meanwhile, the IRS published the September 2026 applicable federal rates in Revenue Ruling 2026-17. The long-term AFR is 5.12% with annual compounding. Mid-term is 4.49%. Short-term is 4.18%.

So a parent can lend at 5.12% on a 30-year note without creating a below-market loan problem, while the market average sits at 6.95%. That spread is the reason the question is being asked in September 2026 and was not being asked as loudly in 2021. I am not going to tell you the spread makes a family loan correct — it frequently does not, for reasons below — but it does explain why the phone is ringing.

The lender side: what a gift has to look like

On a conventional loan, gift funds from an acceptable donor can cover the entire down payment on a primary residence. The donor is generally limited to a relative, a fiance, or a domestic partner. What underwriting needs is unglamorous and specific:

• A signed gift letter naming the donor, the relationship, the dollar amount, the property address, and — the clause people forget — an explicit statement that no repayment is expected.
• Evidence the donor actually had the money. A statement showing the funds leaving the donor’s account.
• Evidence the money arrived. A deposit into the borrower’s account, or a wire directly to escrow.
• A clean audit trail between the two. Cash deposits, third-party transfers and round-number Venmo activity create sourcing problems that take days to unwind.

The sentence that kills deals is “we’ll just call it a loan and they’ll pay us back when they can.” If repayment is expected, it is not a gift, and signing a gift letter that says otherwise is a misrepresentation on a federally related transaction. I will not paper around that, and neither should you.

The tax side: what a loan has to look like

If the family genuinely wants a loan, Internal Revenue Code §7872 is the governing section. A loan carrying interest below the applicable federal rate is a below-market loan, and the foregone interest gets recharacterized — imputed to the lender as interest income and treated as a gift back to the borrower.

Two statutory exceptions matter for the conversations you are having:

• A de minimis exception for aggregate loans between individuals at or under $10,000, where tax avoidance is not a principal purpose. A down payment loan almost never fits this.
• A $100,000 exception, under which imputed interest on gift loans aggregating $100,000 or less is limited to the borrower’s net investment income for the year — and is zero if that net investment income is $1,000 or less.

The mechanics your clients skip: a real note, a stated rate at or above the AFR for the loan’s term, a payment schedule, and — if the parents want any chance at deducting nothing and the child any chance at deducting interest — recording the note against the property. An unrecorded, unsecured family note produces no mortgage interest deduction for the borrower under §163(h), because qualified residence interest has to be secured by the residence.

And the AFR is set by the month the loan is made. A note papered in September 2026 uses September’s table. This is one of the few areas where waiting three weeks changes the answer.

Side by side

The 2026 numbers your clients will ask you for

For 2026 the annual gift tax exclusion is $19,000 per recipient. A married couple splitting gifts can move $38,000 to one child, or $76,000 to a child and a spouse, without touching the lifetime exemption. The federal estate and gift exemption sits at $15 million per individual for 2026.

Which means for most San Diego down payments, the gift tax conversation is a reporting conversation, not a tax conversation. A $150,000 gift to a married couple from two parents uses $76,000 of annual exclusions and files a Form 709 for the balance against a $15 million exemption. The client hears “gift tax” and panics. You get to tell them the number is almost always zero. That is a good phone call to be on.

When each one is the wrong answer

I would rather name the option I am telling someone not to take than pretend both are fine.

Skip the loan when the parents need the money back on a schedule. A note against a home the child may keep for twenty years is not a liquidity plan, and the payment lands on the child’s debt-to-income ratio at exactly the moment they are trying to qualify.

Skip the loan when the buyer is stretching. The AFR spread looks attractive right up until the note pushes the ratios past what will underwrite.

Skip the gift when the parents have blended-family or estate-equalization concerns, or when the money is genuinely meant to come back. A forgiven note documented as a note is a cleaner record than an informal gift everyone remembers differently in nine years.

Skip both when the real problem is that the payment does not work. Money arriving at closing does not fix a monthly number that never penciled.

The structure that usually wins

The version I see work most often is not a pure gift or a pure loan. It is a gift for the down payment — clean, letter-documented, closed — with the family separately using annual exclusions in later years if they want to help further. Two instruments, two purposes, neither one contaminating the other.

Where a note genuinely fits, it gets papered properly and recorded, priced at the AFR in force that month, with the parents comfortable that they may end up forgiving it in annual-exclusion-sized bites. That is a plan. “We’ll figure it out” is not.

Frequently asked questions

Can a family loan be used for the down payment if it is secured by something else?

A loan secured by an asset the borrower already owns is a different analysis than an unsecured family note, and some secured borrowing can be acceptable. It is fact-specific and it needs to be disclosed up front, not discovered in underwriting. Bring it to me before the funds move.

Does the donor have to be out of the transaction entirely?

An acceptable donor generally cannot be a party with an interest in the sale — the builder, the seller, the agent. A parent who is also the listing agent is a conversation, not an automatic no, but it is a conversation to have early.

What if the parents already wired the money three months ago?

Seasoning helps, but it does not erase the question of whether repayment is expected. If it is a gift, it can still be documented as one. If it is a loan, it needs to be disclosed as one.

Is any of this tax advice?

No. I am a mortgage professional, not a CPA or an attorney. Everything above is general education about how lenders and the Internal Revenue Code treat these two structures differently. The return is yours to sign.

Let’s get the structure right before the money moves

If you have a client weighing this, the cheapest hour any of us will spend is the one before the wire goes out. I am happy to be the second voice on the call — I will tell your client plainly what underwriting will and will not accept, and leave every tax question where it belongs, with you.

Book a partnership call and we will build the referral loop so these land on both our desks early instead of late. If a client is ready to get their financing reviewed, they can start a mortgage review here.

Related reading: the complete 2026 guide to buying a house in San Diego, how much of a down payment you actually need in San Diego, and step-up in basis on inherited San Diego property for the other side of the family-money conversation.

Ron Berg is a mortgage professional with The Berg Group, powered by C2 Financial Corporation, serving San Diego and California. He works with CPAs, financial planners and real estate professionals on shared-client financing strategy. Connect on Instagram or book a partnership call.

Ron Berg, NMLS #974839. C2 Financial Corporation, NMLS #135622. Equal Housing Opportunity. Rates referenced are cited national averages from Freddie Mac’s Primary Mortgage Market Survey and are not an offer, quote, commitment, or guarantee of any specific rate, program, or approval. This article is general education, not tax, legal, or investment advice — consult your CPA and attorney regarding your own situation. Source: Freddie Mac PMMS, September 17, 2026; IRS Revenue Ruling 2026-17 (September 2026 applicable federal rates); IRS 2026 inflation adjustments.

Short answer: when a California married couple holds a home as community property, the whole house gets a new cost basis at the first spouse’s death – not half of it. That is IRC Section 1014(b)(6), and it is the single most valuable rule on the board for long-time San Diego owners. Get the vesting wrong and an heir can inherit a capital gains bill that did not have to exist.

Who this is for

CPAs and enrolled agents with San Diego clients who own appreciated real estate – and the adult children who call you in October asking what to do with Mom’s house. I am a mortgage broker, not a CPA. Nothing here is tax advice, and the numbers on any specific return are yours to run. What I can give you is the lender’s side of a conversation you are already having, because financing decisions made in the first ninety days after a death quietly determine how clean the tax picture looks later.

The thing most heirs believe, and it is wrong

The belief: when one spouse dies, only their half of the house gets stepped up to current value. The surviving spouse keeps the old basis on their half, and when the house eventually sells, half the appreciation is taxable.

In a community property state, that is not how it works. Under Section 1014(b)(6), property that is community property under state law receives a new basis on both halves at the first death. California is a community property state. For a couple who bought in Clairemont in 1987 for $135,000 and whose home is worth north of a million today, the difference between a half step-up and a full step-up is not a rounding error – it is the entire decision about whether the surviving spouse can afford to sell.

How title was held decides almost everything

The row that causes the most trouble is joint tenancy. Plenty of California couples took joint tenancy vesting at the title company in 1994 because someone said it avoids probate, without anyone explaining what it costs at the first death. Whether that property can still be established as community property in substance is a real question with real procedures behind it – and it is a question for the estate attorney and the CPA, not for me and not for the title officer. I raise it because I see the vesting on the preliminary report before anyone else does, and flagging it early is worth more than flagging it at the closing table.

The date-of-death value is a document, not a memory

The new basis is the fair market value on the date of death. That number needs to be supportable years later, when the house finally sells and someone has to defend the gain calculation. A Zestimate screenshot is not that. A retrospective appraisal by a qualified appraiser, dated to the death, is.

There is also an alternate valuation date – six months after death – available to the executor only where the election reduces the value of the gross estate, and only if the property was not disposed of first. For most San Diego families whose estates land well under the current federal exemption, the alternate date rarely helps and often just adds a decision. Worth knowing it exists; rarely worth using.

One practical note: the appraisal a lender orders is not the appraisal the return needs. A purchase or refinance appraisal is dated today and written for a lender’s collateral file. A date-of-death valuation is dated to the death and written for a different reader. When a family orders one and assumes it covers both, somebody ends up paying for a second one anyway.

Where the loan enters the picture

Three situations put a lender in the middle of an inherited-property file, and all three have timing that interacts with your work:

• The sibling buyout. One heir wants the house, the others want cash. That is a financing event, and how it is structured – whether it is treated as a purchase or as a refinance of inherited property – changes the loan terms available and the paperwork required. It is worth a phone call before anyone signs anything.
• Refinancing to pull cash out of an inherited property. Whether the interest on that new money is deductible depends on what the money is used for, not on what the loan is called. I wrote up the mechanics in interest tracing on a cash-out refinance – it is the question I get asked most often after a step-up conversation.
• Selling instead. If the family is selling rather than keeping, the vesting and the transfer path matter to the listing side too. My colleague on the real estate side and I walked through the difference between a trust sale and a probate sale here – the two get used interchangeably in conversation and they are not the same transaction.

On rates: the 30-year fixed-rate mortgage averaged 6.76% in the Freddie Mac Primary Mortgage Market Survey published September 10, 2026, up from 6.71% the week before and 6.35% a year ago. That is a cited national average, not an offer or a quote. It matters here because a sibling buyout financed at today’s averages carries a real monthly cost, and families who spend eight months deciding sometimes find the math has moved underneath them.

What I am not going to tell you

I am not going to hand you a San Diego median sale price to anchor a date-of-death estimate on. The published medians this fall disagree with each other by more than $150,000 depending on the source and the geography, and a number that wobbles that much has no business inside a basis calculation. What is stable enough to describe the market: roughly 6,400 active listings countywide, about 3.2 months of supply – the highest since 2019 – and a median of about 25 days on market. Use those for context. Use an appraiser for the number.

Three things I watch go wrong

1. Nobody orders a valuation for two years. Retrospective appraisals get harder and more expensive the further you are from the date. Order it early even if the family has no plans to sell.
2. The house transfers before anyone checks the vesting. Once it moves, options narrow.
3. An heir takes over the payments informally. Paying a deceased parent’s mortgage out of a personal account for three years while title sits unchanged creates a tangle for everyone – lender, CPA, and the other siblings.

Frequently asked questions

Does the step-up apply to a rental property too?

The basis rules under Section 1014 reach capital assets broadly, rental real estate included. What differs on a rental is everything that rides alongside it – prior depreciation, passive loss carryforwards, the whole history of the schedule. That is squarely your territory, not mine.

Does refinancing an inherited property reset the basis?

No. Debt and basis are separate. Borrowing against a property does not change what it cost you for tax purposes. This one surprises people constantly.

Should the family sell now or hold through year-end?

That depends on facts I do not have and a return I do not prepare. What I can say is that the financing question and the tax question should be answered in the same room, not six weeks apart.

Let’s compare notes before your clients call

If you have a client with an inherited San Diego property this quarter, I am glad to look at the vesting and the financing options alongside whatever you are modeling – no charge, no expectation. The families who come out of this cleanest are the ones whose CPA and lender talked to each other in week two instead of month eight. Book a short call with me here.

Ron Berg is a mortgage broker with The Berg Group, powered by C2 Financial Corp, working with buyers, homeowners, and referral partners across San Diego. His family emigrated from Brazil and recently finished writing a book on their lineage – which is probably why inheritance files hold his attention longer than they should. Book a partnership call.

This article is educational and is not tax, legal, or accounting advice. Tax outcomes depend on individual facts; clients should rely on their own CPA and estate attorney. Rates shown are cited national averages from Freddie Mac and are not an offer, quote, or commitment to lend. Ron Berg, NMLS #974839. C2 Financial Corp, NMLS #135622. Equal Housing Opportunity.

5 minute read

When a lender looks at your client’s Schedule K-1, the number they start with is usually not the number your client thinks it is. Lenders begin with ordinary business income reported on the K-1, then treat cash distributions as evidence that your client can actually reach that income, not as the income itself. That single distinction is behind most of the K-1 loan files I see stall in underwriting.

Who this is for

This is written for San Diego CPAs and tax preparers with business-owner clients: partnerships, LLCs taxed as partnerships, and S corporations. If you have spent September finishing extended Forms 1065 and 1120-S ahead of the September 15 extended deadline, the K-1s you are issuing this week will be the documents a lender reads if that client buys or refinances in the next twelve months.

I am not writing this to tell you how to prepare a return. You know that work far better than I do. I am writing it because the mortgage side of the file is where a perfectly correct return sometimes produces an outcome your client did not expect, and a short conversation in September prevents a difficult one in March.

The belief that causes the most trouble

Most business owners believe the income a lender uses is the money they actually took out of the company. It is an intuitive belief and it is usually backwards.

Under Fannie Mae’s Selling Guide treatment of K-1 income, ordinary business income reported on the Schedule K-1 may be included in the borrower’s cash flow provided the lender can confirm the business has adequate liquidity to support the withdrawal of those earnings. Distributions matter because they answer the access question. If the K-1s show a documented, stable history of cash distributions consistent with the level of business income being used to qualify, the lender generally does not need to go further into a liquidity analysis.

So a client who leaves earnings in the company for good business reasons is not disqualified from using that income. They are simply going to be asked to prove the company could have paid it out. That is a different conversation, and it is one the business’s own balance sheet usually answers.

The 25% ownership line

Ownership percentage is the hinge the whole file turns on.

This catches people. A client with a 24% interest in one operating company and a 30% interest in a small side LLC is self-employed because of the side LLC, and the side LLC’s returns come into the file even if it produces almost nothing. When you are the one who knows the cap table, flagging that early saves two weeks.

What “adequate business liquidity” actually means

When a liquidity review is required, lenders commonly run a ratio off the business balance sheet. The current ratio divides current assets by current liabilities. The quick ratio does the same but strips out inventory. A result of 1.0 or higher is generally read as the business being able to support the withdrawal of earnings.

A few things follow from that, and they are all things a CPA controls or at least sees first:

• A balance sheet loaded with inventory can pass a current ratio and fail a quick ratio. Knowing which one a lender is applying changes the answer.
• A shareholder loan sitting in current liabilities can drag the ratio below 1.0 even when the business is healthy.
• Year-end timing matters. A December 31 snapshot taken right after a large payables run can misrepresent a normal year.

None of that is a reason to change how you prepare the return. It is a reason to know, before the client makes an offer on a house, whether the balance sheet tells a flattering story or an awkward one.

Guaranteed payments, losses, and the second year

Three details that decide more files than they should:

Guaranteed payments to partners. These are frequently the steadiest, cleanest income on the whole return, and they are often overlooked by the borrower when they describe their income out loud. Point them out.

Losses are not neutral. A K-1 loss from a second entity generally reduces qualifying income, even if the loss was entirely non-cash. A client with a strong operating business and a small real estate LLC throwing off paper losses can be surprised by how much those losses cost on the mortgage side. The depreciation piece is often added back, but not all of it and not automatically.

Two years, trending the right way. Two years of K-1s is the normal expectation. If year two is materially lower than year one, the lower figure usually drives the analysis and the file needs an explanation. If your client had a genuinely unusual year, a short written explanation from you carries real weight with an underwriter. I have seen a two-paragraph CPA letter move a file that nothing else was moving.

The tension nobody enjoys naming

Your job includes legally minimizing your client’s taxable income. The mortgage process rewards showing income. Those two things pull in opposite directions and pretending otherwise helps no one.

I am not going to suggest anyone report income they did not earn, and I would not work with a CPA who would. The practical answer is timing. If a client is planning to buy or refinance inside the next two years, that fact belongs in the conversation while the return is still being planned, not after it is filed. Sometimes the right call is still the aggressive one and the client buys less house. Sometimes a legitimate structural choice, made early and for real business reasons, changes the picture. Either way, the client should make that trade knowingly.

For context on the borrowing side of that math: Freddie Mac’s Primary Mortgage Market Survey put the 30-year fixed national average at 6.76% for the week of September 10, 2026, up from 6.71% the prior week, with the 15-year at 6.09%. A year ago the 30-year averaged 6.35%. Those are national averages, not offers or quotes, and an individual borrower’s terms depend on the full file.

When to skip all of this

If your client’s K-1 interest is small, passive, and not needed to make the numbers work, leave it alone. Dragging a minor entity’s returns into a file that already qualifies on W-2 income adds documentation, adds conditions, and adds a chance for something to look odd under a microscope. More income on paper is not automatically a better file. Sometimes the cleanest path is the narrow one.

Frequently asked questions

Can a client use K-1 income if the business never distributed cash?

Potentially, yes, but the lender will need to confirm the business had adequate liquidity to support withdrawing those earnings. Without a distribution history, the balance sheet does the work.

Does a K-1 loss always reduce qualifying income?

Generally it reduces it, though certain non-cash items such as depreciation are commonly added back. The specifics depend on the entity type and the loan program, which is why the actual returns matter more than a summary.

My client owns exactly 25%. Which side of the line is that?

Twenty-five percent or more puts the borrower on the self-employed side. Exactly 25% counts.

How far back will a lender look?

Two years of returns is the standard expectation for a self-employed borrower. A shorter history is not automatically fatal but it narrows the options considerably.

What is the single most useful thing I can send with a client referral?

The last two years of business returns with all K-1s, and one sentence about anything unusual in them. That sentence saves more time than the rest of the file combined.

Related reading on this site

• How self-employed qualifying income is calculated covers the broader framework this post sits inside, including sole proprietors and add-backs.
• Interest tracing on a cash-out refinance is the other place CPA and lender work overlaps most often.
• 1031 exchange financing for clients moving investment property.

Ron Berg is a mortgage professional with The Berg Group, powered by C2 Financial Corp, working with San Diego buyers, homeowners, and the CPAs and real estate professionals who advise them. Connect on Instagram @calimortgageguy or book a partnership call.

Ron Berg | NMLS #974839 | C2 Financial Corp NMLS #135622 | Equal Housing Opportunity. This article is educational and is not tax, legal, or financial advice, and is not an offer or commitment to lend. Rates cited are national averages published by Freddie Mac, not quotes. Underwriting guidelines referenced are general and subject to change; individual loan terms depend on a complete application and full review. Clients should rely on their own tax professional for tax matters.

Updated September 18, 2026 with current rate figures and the year-end deadline.

Short answer: the collateral does not determine the deduction. The use of the proceeds does. A cash-out refinance on a San Diego primary residence can generate fully deductible mortgage interest, fully deductible rental interest, deductible business interest, or nondeductible personal interest — and the same loan can generate several of those at once, in proportions set by how the borrower spent the money.

I write this one for the CPAs and tax preparers we work with, because it is the single most common place I see a mortgage and a tax return disagree with each other. The borrower thinks “it is a mortgage on my house, so it is mortgage interest.” The regulation does not care what they think.

Who this is for

This is for CPAs, EAs, and tax preparers with San Diego clients who pulled equity out in the last eighteen months — which, given where local equity sits, is a lot of clients. It is also for the preparer who has a Form 1098 showing $41,000 of interest and a client who cannot clearly account for where $250,000 of cash-out proceeds went.

If that describes a file on your desk, the conversation to have before year-end is not about the 1098. It is about the bank statements.

Why the 1098 is not the answer

Form 1098 reports interest paid on a loan secured by real property. It does not characterize that interest. The lender has no idea what the borrower did with the money and no obligation to find out.

So the 1098 is a starting number, not a conclusion. The characterization work happens downstream, and it happens by tracing.

This matters more after a refinance than after a purchase. On a purchase loan, the tracing is trivial: the money bought the house. On a cash-out, the “rate and term” portion generally inherits the character of the debt it replaced, while the new cash-out portion takes the character of whatever the borrower did with it. One loan, two histories.

The four destinations

Broadly, cash-out proceeds land in one of four buckets. General framework only — the specific treatment of any dollar is a determination for the client’s tax professional.

Note the fourth row, because it is the one that surprises people. Paying off a credit card with home equity does not convert that interest into mortgage interest for deduction purposes. It converts a high rate into a low rate, which is a fine reason to do it — just not a tax reason.

And note the first row’s limit: qualified residence interest is subject to the acquisition-indebtedness cap, which is $750,000 for debt incurred after December 15, 2017. I covered how that cap behaves in San Diego, where loan sizes bump into it routinely, in the mortgage interest deduction post. Tracing decides which bucket; the cap decides how much of the Schedule A bucket survives.

The timing trap

Here is the piece that costs clients the most, and it is a sequencing problem rather than a tax problem.

Cash-out proceeds fund into a bank account. That account already has money in it. The client then spends over the following months from a commingled balance. Six months later, nobody can say with any confidence which dollars were the loan proceeds.

Tracing works on actual expenditures. When the proceeds are commingled and the trail goes cold, the fallback characterization is rarely the favorable one. The fix is embarrassingly simple and has to happen before the money moves:

1. Open a separate account for the proceeds. Not a sub-ledger. A separate account. Fund it at closing and spend from it directly.
2. Spend it on one thing, or on a small number of clearly documented things. Every transfer out should have an obvious destination.
3. Spend it reasonably promptly. The longer proceeds sit, the more likely they mingle with other deposits.
4. Keep the closing statement with the bank records. The Closing Disclosure establishes the amount and date; the bank statements establish the use. You need both halves.

When a client tells me they are pulling cash out and they have a CPA, this is the conversation I ask them to have first — not after. It takes ten minutes at the front end and it is unrecoverable at the back end.

Where this shows up in the current market

The 30-year fixed-rate mortgage averaged 6.95% in Freddie Mac’s Primary Mortgage Market Survey dated September 17, 2026, up from 6.76% the prior week; a year earlier it averaged 6.26%. The 15-year averaged 6.26%. That is a fourth consecutive weekly increase, following the Federal Reserve’s quarter-point move on September 16. Those are cited national averages published weekly, not offers or quotes.

Why that matters for tracing: at these rates, very few San Diego homeowners are refinancing purely for rate. They are refinancing for access — to a rental down payment, a business, an ADU. Which means a much higher share of current refinance volume is cash-out, and a much higher share of current refinance volume needs tracing analysis.

The mechanical side of getting equity out is covered in our cash-out refinance walkthrough. If the client’s plan is to redeploy the proceeds into investment property, the 1031 exchange financing piece covers a related structuring question worth raising in the same meeting.

The four questions to ask the client

If you have limited time before year-end, these four get you most of the way:

• Was any of this a cash-out, or was it rate-and-term only? If rate-and-term, tracing is usually straightforward and the prior debt’s character carries.
• What was the cash-out amount, and on what date did it fund? From the Closing Disclosure, not from memory.
• Where did that money go, dollar for dollar? Ask for statements. “Improvements, mostly” is not a traceable answer.
• Did the proceeds sit anywhere first, and did other deposits land in that account? This is the question that determines whether you have a clean trace or a reconstruction project.

When tracing is not the issue at all

Worth saying, because not every refinance needs this workup:

• A pure rate-and-term refinance with no cash out. The replacement debt generally inherits the character of the debt retired. There is little to allocate.
• A client who does not itemize. If the standard deduction wins, the Schedule A analysis is academic — though the Schedule E and Schedule C portions still matter, which is exactly why people miss them.
• Small cash-out amounts spent on documented improvements. Same bucket as the rest of the loan, and the allocation is a formality.
• Proceeds that went entirely to personal consumption. Nothing to trace toward a deduction. Tell the client plainly and move on.

Frequently asked questions

Is interest on a cash-out refinance deductible?

It depends on what the proceeds were used for, not on the fact that a home secures the loan. Proceeds used to improve the residence securing the debt can generally produce qualified residence interest; proceeds used for rental or business purposes are generally traced to those activities; proceeds used for personal consumption generally produce nondeductible personal interest. The client’s tax professional makes that determination on the facts.

Does a home equity line of credit follow the same rules?

The same tracing concept applies — the use of the draw drives the character. Lines of credit are harder to trace in practice because clients draw repeatedly over time and often for mixed purposes. Contemporaneous records matter even more with a line than with a lump-sum refinance.

Can one loan produce interest on more than one schedule?

Yes, and it is common. A $300,000 cash-out split between an ADU, a rental down payment, and paying off a car would generally allocate across three characterizations in proportion to the traced amounts. There is no rule that a single loan gets a single answer.

How does this affect what a client can borrow?

It does not. Tracing is a tax characterization exercise and has no bearing on underwriting, program eligibility, or loan amount. All loans are subject to underwriting review. The two analyses run on separate tracks — which is precisely why they need to be coordinated by someone.

What I would do this quarter

Pull the client list for anyone who closed a refinance in 2026, flag the cash-outs, and request Closing Disclosures plus the sixty days of bank statements that follow each funding date. Do it before year-end, while the Q4 installment and the extension-season files are both still in front of you. Reconstructing a trace in April is expensive; documenting one now is free.

If you would rather have the loan-side facts straight from the file, I am happy to walk a specific transaction with you. The homeowner guide covers the borrower-facing version of the same decision.

Ron Berg is the founder of The Berg Group, a San Diego mortgage team that works alongside CPAs, financial planners, and real estate professionals on the financing side of client decisions. Want the loan facts for a specific file? Book a call.

Sources: Freddie Mac Primary Mortgage Market Survey, survey dated September 17, 2026; Treasury Regulation §1.163-8T (allocation of interest expense); IRS Publication 936, Home Mortgage Interest Deduction; IRS estimated tax guidance.

Ron Berg | NMLS #974839 | C2 Financial Corp, NMLS #135622 | Equal Housing Opportunity. Rates referenced are cited national averages published by Freddie Mac and are not offers, quotes, or commitments to lend. All loans subject to underwriting review; program terms and availability vary. This article is general education for tax professionals and is not tax, legal, or accounting advice. Characterization of interest expense depends on the specific facts of each taxpayer’s situation and should be determined by the taxpayer’s own tax advisor.