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@sjrcpa wrote:

It doesn't really need to be undone, although that's not a bad idea. It does need to be reported correctly for tax purposes.

I can see how you have a mortgage covering 2 or more properties. How do you get one tax bill for 2 properties though?

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If it's not undone, will it still qualify for the exclusion of gain on primary residence?  Probably, if looking at substance over form, but I wouldn't want to be the one having to defend that. 

And where did someone come up with the idea of just splitting everything 50/50 between Schedule E and Schedule A?  Weren't these two properties bought at different times for different amounts?  Were there originally two mortgages, refinanced into one?  If the home cost $450K and the rental cost $150K, a 75%/25% split would be indicated. 

I'm waiting now for the additional fact that the rental house is occupied by the daughter and grandkids.  Who buys the house next door as a rental, other than helicopter parents?  At least that is what I have seen more than once.