What Closing Costs Are Tax Deductible for Rental Property?

  • Apr 08, 2024
  • 4 min read
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Do you ever catch yourself thinking, “Are rental properties a good investment?” Well, we can tell you with certainty that they are, and for many reasons.

Not only does real estate investing boost your wealth and make it cheaper to borrow money, but it comes with numerous tax benefits. You can make dozens of standard deductions to lower your tax liability yearly in addition to the tax deductions when you buy or sell an investment property, such as those for closing costs.

What closing costs are tax deductible for a rental property? Find out below.

What Are Closing Costs?

Closing costs are the fees and expenses you pay to close escrow that don’t include the down payment. You must pay these fees whether you buy a primary residence or rental property.

You can expect closing costs to amount to 2-5% of the property’s purchase price. However, some title companies offer discounts to real estate investors when buying a residential rental property, lowering the costs.

Despite the fees, a rental property bought with a mortgage will often yield a high ROI for investors. This is something to factor in when you calculate ROI on a rental property.

Notably, if you refinance your mortgage, you must pay closing costs again, like when you purchased the property. So, consider these costs if you’re thinking about refinancing an investment property.

Types of Closing Costs to Expect

The types of closing costs on an investment property include:

  • Inspection and property appraisal fees
  • Mortgage fees
    • Credit report
    • Loan application
    • Origination fees
    • Underwriting fees
  • Prepaid and impound amounts for HOA fees, homeowners insurance, mortgage interest, and property taxes
  • Professional fees
    • Lawyer fees
    • Tax professional fees (e.g., CPA, financial advisor)
  • Title fees
    • Escrow fees
    • Recording fees
    • Title search fees
    • Transfer taxes

Additionally, those who make a downpayment of less than 20% likely must also pay a mortgage insurance premium (MIP).

What Closing Costs Are Tax Deductible for Rental Property?

According to the IRS, homeowners can deduct some closing costs on their tax return using Schedule E (Form 1040) when they purchase a property.

Yet, it doesn’t treat all deductible closing costs in the same way. Some expenses are an instant write-off, while others you deduct over time.

Here are three deductions taxpayers can make immediately.

Mortgage Interest

Mortgage interest deduction allows you to deduct the interest portion of your mortgage payment as a closing cost. However, it doesn’t apply to the principal mortgage amount.

You can add other mortgage-related expenses like broker commission fees and recording fees to the cost basis.

Mortgage Points

Mortgage points (or discount points) are payments you make to your lender in exchange for decreasing the interest rate. Points include expenses like credit check fees and paperwork preparation fees.

One point equates to 1% of your mortgage. Thus, one point on a $300,000 mortgage is $3,000. Typically, you will spread this deduction over the life of the loan and not make a lump sum deduction in the first year.

Deductible Real Estate Taxes

You can also deduct prorated property taxes paid at the time of closing as a tax expense. For instance, let’s say the property taxes for the year are $4,000. If you close escrow on July 2 (the exact halfway point of the year), you’ll be responsible for paying $2,000 in property taxes for that year.

If the seller has already paid for the entire year, they will receive a $2,000 credit, and you will receive a bill for $2,000. However, this is tax deductible.

Can You Deduct Closing Costs When Selling a Rental Property?

While you can deduct some closing costs when you buy a rental property, there are also rental property tax deductions when selling a property.

So then, what closing costs are tax deductible when selling rental property? Explore these deductibles below.

Reduce Selling Price by Closing Costs Paid

As a seller of a rental property, you can deduct the following closing costs:

  • Legal fees
  • Real estate commissions
  • Recording fees
  • Title insurance fees
  • Transfer taxes

By lowering the profit (taxable income) from the sale of the house, you reduce your tax liability.

Recapture Depreciation

You can use the annual depreciation deduction while you own the property to reduce your taxable net rental income. Residential rental properties usually depreciate at a rate of 3.636% each year for 27 years.

However, when you sell the property, you’ll have to recapture the depreciation by paying a depreciation recapture tax. The amount you owe depends on your ordinary income tax rate.

Further, if an expense is not immediately tax-deductible, you can likely add it to your cost basis and recover it over time with depreciation. Settlement fees and closing costs that add to your basis include:

  • Abstract fees
  • Legal fees
  • Recording fees
  • Surveys
  • Title insurance
  • Transfer taxes
  • Utility installation service charges

To ensure you can add an expense to the basis, refer to IRS Publication 527, which lists ineligible costs, or IRS Publication 551, “Basis of Assets.”

Capital Gains Tax

When you reduce the net sales price of your property, you lower the amount of capital gains tax you must pay. The long-term capital gains tax rate is 0%, 15%, or 20%, depending on your income bracket. These rates assume you owned the property for more than one year.

Work With All County to Manage Your Property

When considering what closing costs are tax deductible for rental property, it’s essential to explore the topic in depth because IRS laws propose different rules for different expenses.

Now you understand that expenses are either a one-time write-off or deducted from your cost basis and factored into depreciation. Additionally, there are different deductible closing costs when buying and selling a rental property.

If tackling your investment property finances is too much for you, find a property manager from All County to help.

Whether you need assistance to tackle your deductible expenses for the tax year, find tenants, or undertake maintenance tasks, we help landlords with all things related to rental properties. Contact us today to learn more about how we can help.

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