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Agree with some other commenters that your wife's reasoning makes no sense. Best option will be to do cashout on current rental as you'll be able to fully write off the interest on your schedule E and cannot write off the interest if you take a HELOC on primary to buy a rental. Furthermore, if only 3 years left; new cashout mortgage could potentially increase your cashflow (assuming you got a mortgage 10+ years ago). With the Trump tax cuts, one gets way better write-off on a rental vs primary residence. As most people nowadays take the higher standard deduction.
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