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2. Even if they were to take out a loan, it wouldn’t be reported as mortgage interest deduction on schedule A. Again it would be investment interest expense on schedule E.

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Not to be pedantic or anything, but interest paid while a property is being rehabbed may be investment interest, but it is not reported on schedule E. It would be reported on sched A (after a detour on Form 4952 where it’s limited to investment income) as investment interest, or probably more properly, capitalized as part of the cost of the property. Sched E is for reporting income for a trade or business that doesn’t go on Sched C or F. So if the property isn’t available for rent, the expenses shouldn’t (or at least legally can’t) be deducted there. “Investment interest” has a very specific meaning under the tax code, and it’s never deductible on schedule E.