Tax Impact of Real Estate Purchase Closing Costs
So many different types of costs are involved in a real estate purchase that a special report is provided at closing. A frequent question of taxpayers is how much of the closing costs are tax-deductible. Details about the tax impact of each item is covered in a CPE course for tax professionals.
Acquisition costs include title insurance, recording fees, legal fees, survey fees, document preparation fees, and any other expenses associated with purchase. These amounts are added to the cost basis of the property. Doing so reduces a future gain from the property sale. Basis is also used to calculate depreciation when the acquired property is rental real estate. Retaining the closing statement as a record of cost basis is therefore very important. The tax assistance of enrolled agents requires records of the taxpayer.
Real estate taxes are deductible in the year they are paid. The owner of a property pays the entire property tax bill before the due date. This means that a seller usually reimburses a purchaser at closing with an advance covering the seller’s pro rata time of ownership. This reduces the purchaser’s part of the tax-deductible real estate taxes. However, a buyer adds to cost basis any reimbursement to the seller for real estate taxes the seller paid in advance of the due date. Other amounts, such as a few days of rent, paid by the seller reduce the purchaser’s basis.
No tax deduction is available for amounts paid to an escrow account with the lender. These are simply advances for future real estate taxes and insurance. The real estate taxes paid from the escrow account are deductible when paid later. Enrolled agents are qualified to help taxpayers with common matters like these itemized deductions as well as unusual tax situations. Basic topics are covered in free CPE available to enrolled agents.
Fees charged by a mortgage company for items such as a credit report or an appraisal are not tax-deductible. Premiums for mortgage insurance are deductible when the property is a residence. Other costs paid to the lender include pro rated interest for a partial month and points associated with the mortgage. Interest is tax-deductible. Points are also deductible when incurred for purchase of a principal residence. For rental real estate, points are amortized as a deduction over the life of the mortgage.
There are other considerations involved in purchasing real estate. A basic concept is that the purchase involves both land and a building. For rental property, only the building is depreciated. The land value is segregated and not depreciable.
Addressing the tax treatment of various closing costs is tricky for most purchasers of real estate. Taxpayers in this circumstance can locate professional assistance from the membership of an enrolled agent association.
Another possible acquisition technique involves a like-kind exchange. These purchases involve only business or investment property. The cost basis in a like-kind exchange includes the adjusted basis of the property relinquished in the exchange. The tax impact from selling the relinquished property is transferred to the acquired property. This defers the payment of tax on the relinquished property. Accomplishing a tax-deferred like-kind exchange involves following some specific procedures required by the IRS. Tax professionals learn to correctly handle these situations in their tax continuing education.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.
