Debt Recycling: How to Make Your Mortgage Interest 100% Tax-Deductible
Debt Recycling: How to Make Your Mortgage Interest 100% Tax-Deductible
CORE INSIGHTS
- The Inefficiency: Paying 7% mortgage interest with after-tax dollars is costly. Investment interest expense, however, is deductible against investment income.
- The Strategy: “Debt Recycling” involves selling investments to pay down your mortgage, then immediately re-borrowing (HELOC) to buy the investments back.
- The Result: Your net worth and debt level stay the same ($0 change), but the debt is now “Investment Debt,” making the interest fully tax-deductible.
In the U.S., personal mortgage interest is a weak deduction. By changing the purpose of your loan—from “buying a house” to “buying investments”—you slash your effective interest rate by 30-40%. This is not evasion; it is the IRS Interest Tracing Rule at work.
Loan: 7.0% Interest.
- Standard Mortgage: Cost = 7.0% (After-tax dollars).
- Recycled Debt: Cost = 7.0% * (1 – 0.45 Tax Rate) = 3.85%.
*You just refinanced without asking the bank.
What-If Scenario: $400k Portfolio & Mortgage
| Metric | Status Quo | Debt Recycling |
|---|---|---|
| Interest Paid | $28,000 | $28,000 |
| Tax Deduction | $0 (Standard) | $11,200 (Invest Exp) |
| Net Cost | $28,000 | $16,800 |
Visualizing the Interest Savings
*Figure 1: Net Cost. The Green bar (Recycled) is significantly lower due to the tax shield.*
Strategic Action Steps
Get a HELOC or Cash-Out Refi ready before selling. You need immediate access to cash to execute the “buy back.”
Sell taxable assets (watch for capital gains!). Use cash to pay down the mortgage principal.
Draw from the credit line and transfer directly to brokerage. Do not mix with personal checking. The paper trail must be clean.
The Bottom Line: Who Should Choose What?
- Do This: High W-2 earners with taxable investments and a mortgage rate >5%. It’s a guaranteed arbitrage.
- Avoid This: If selling stocks triggers massive capital gains tax that outweighs the interest savings.
Frequently Asked Questions
What is Debt Recycling?
A strategy where you sell investments to pay off a mortgage, then re-borrow to buy investments back, converting the debt to deductible investment debt.
Why does this work legally?
IRS ‘Interest Tracing Rules’ allow interest deduction based on the *use* of loan proceeds. If used for taxable investments, it is deductible.
What is the Wash Sale risk?
If you sell stocks at a loss and buy them back within 30 days, it triggers a Wash Sale. Wait 31 days or buy a correlated substitute.