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Residential Real Estate Rental Property

Rental Property Mortgage Refinance – What is Deductible

When you purchase or refinance a rental property mortgage, certain loan origination costs are fully deductible in the year you pay them. These expenses include interest and deductible real estate taxes.  These items should be included on Schedule E line 18.

Certain other expenses you pay to originate a loan or refinance a mortgage for your rental property are not deductible as interest expense.  Depending on the type of expense, they should be amortized over the life of the mortgage or added to the basis of your property and recognized through depreciation of the property.

Refinance Costs that Increase your Rental Property Basis

According to IRS Publication 551,  your basis includes the settlement fees and closing costs for buying propertyYou cannot include in your basis the fees and costs for getting a loan on property. A fee for buying property is a cost that must be paid even if you bought the property for cash.  The following items are some of the settlement fees or closing costs you can include in the basis of your property.

  • Abstract fees (abstract of title fees);
  • Charges for installing utility services;
  • Legal fees (including title search and preparation of the sales contract and deed);
  • Recording fees;
  • Surveys;
  • Transfer taxes;
  • Owner’s title insurance
    ***Settlement costs do not include amounts placed in escrow for the future payment of items such as taxes and insurance.

Refinance Costs that Should be Capitalized and Amortized over the life of your Mortgage

Charges connected with getting a loan are considered a capital expenses.  These types of costs should be amortized over the life of the loan using form 4652 (considered amortizable intangibles under IRC 446).  To identify your “loan costs”, add all the loan costs from your property’s settlement statement (typically lines 800-807) and divide it by the loan term (e.g., 20 years).

  1. Points (discount points, loan origination fees).
    1. Mortgage insurance premiums.
    2. Loan assumption fees.
    3. Cost of a credit report.
    4. Fees for an appraisal required by a lender.
  2. Fees for refinancing a mortgage.

How To Deduct Amortization (IRS Publication 535 Chapter 8 )

To deduct amortization that begins during the current tax year (for example, you refinance in the current year), complete Part VI of Form 4562. You will also report amortization from previous years in part VI of form 4562.

For example, in 2009, you began to amortize a lease. In 2010, you began to amortize a second lease. Report amortization from the new lease on line 42 in part VI of your 2010 Form 4562. Report current year amortization from the 2009 lease on line 43 in part VI of your 2010 Form 4562.

If you do not have any new amortizable expenses for the current year, you are not required to complete Form 4562 (unless you are claiming depreciation expense). Report the current year’s deduction for amortization that began in a prior year directly on the “Other deduction” or “Other expense line” of your return (line 18H of Form E for real estate rental property).

References:

IRS Publication 551 Basis of Assets 

IRS Publication 527 (2010), Residential Rental Property

IRS Publication 535 Business Expenses

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Any federal tax advice contained in this website is general in nature was not intended to be used and cannot be used for the purpose of (1) avoiding any penalty that may be imposed by the IRS or (2) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

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