Tax Treatments of Closing Costs and Other Items When Purchasing Investment Properties

real-estate-icon-1408323-mWhen purchasing an investment property, most investors understand the closing statement (HUD-1) and the immediate financial impact each line item has to them upon purchase of the property.  What seems to be an area of confusion, is the tax treatment of each these items.  The following is a line by line description of the HUD-1 (from the buyer’s side) and their tax treatments.

Here is link to the HUD-1 to follow while reading.

100.  Gross amount due from borrower

101. Contract sales price – This is the purchase price of the property and must be depreciated once placed in service.  IRS guidelines require residential rental properties to be depreciated over 27.5 years and commercial rental properties to be depreciated over 39 years.  One thing to keep in mind is even if you are buying a condo or townhome which shares common land, a portion of the purchase price must be allocated to land.  Land is not depreciated and reduces the depreciable basis of the property.

102.  Personal property – This is the purchase price of any personal property included with the property such as furniture, fixtures or equipment and must be depreciated.

103.  Settlement charges to borrower (also seen on line 1400) – These are the total costs that appear on page two and are discussed in detail below.   This is the area we see the most confusion over the tax impact.

Adjustments for items paid by seller in advance

106. City/town taxes – These are allowed as a current rental deduction but must be reduced by any amount on Line 210.

107. County taxes – These are allowed as a current rental deduction but must be reduced by any amount on Line 211.

108. Assessments – These are allowed as a current rental deduction but must be reduced by any amount on Line 212s.  If the assessments are specifically labeled as local improvement district (LID) assessments, they are not currently deductible and must be amortized over the life of the loan.

200. Amounts paid by or in behalf of borrower

201. Deposit or earnest money.

202. Principal amount of new loan(s).

203. Existing loan(s) taken subject to.

There amounts are included in the purchase price on lines 101 and 102 above.  These items are not specifically deducted or amortized.

Adjustments for items unpaid by seller

210. City/town taxes.

211. County taxes.

212. Assessments.

These amounts reduce any deductible amounts on lines 106, 107 and 108 above.

700. Total Sales/Broker’s Commission – This is paid by the seller and has no tax effect on the buyer.

800. Items payable In connection with loan

801. Loan origination fee.

802. Loan discount.

These items must be amortized over the life of the loan.  Many people think that these amounts (usually referred to as points) are a current tax deduction.  The only time that points are current deductions is when they are paid upon purchase of a primary residence.  Points paid upon refinancing of a primary residence or purchase of investment property is amortized over the life of the loan.

803. Appraisal fee.

804. Credit report.

805. Lender’s inspection fee.

806. Mortgage insurance application fee.

807. Assumption fee.

These items must be amortized over the life of the loan.

900. Items required by lender to be paid in advance

901. Prorated interest – Deductible as a current rental expense.

This amount will usually appear on Form 1098 that you will receive at the end of the year showing how much interest you paid during the year. However, not all lenders include this amount on the form so be sure to check with your lender to find out.

902. Mortgage insurance – Amortized over the period the payment covers, which is usually one year.

903. Hazard insurance – Amortized over the period the payment covers, which is usually one year.

1000. Reserves deposited with lender

1001. Hazard insurance.

1002. Mortgage insurance.

1003. City property taxes.

1004. County property taxes.

1005. Annual assessments

These amounts are deposited (escrowed) with the lender and are deductible when they are disbursed from escrow by the lender. These amounts paid from escrow should be reported on your Form 1098 at the end of the year.

1100. Title Charges

1101. Settlement or closing fee.

1102. Abstract or title search.

1103. Title examination.

1104. Title insurance binder.

1105. Document preparation.

1106. Notary fees.

1107. Attorney’s fees.

1108. Title insurance.

1109. Lender’s coverage.

1110. Owner’s coverage.

All of these amounts are added to the cost basis of the property (line 101) and must be depreciated.

1200. Government recording and transfer charges

1201. Recording fees.

1202. City/county tax/stamps..

1203. State tax/stamps.

These amounts are added to the cost basis of the property (line 101) and must be depreciated.

1300. Additional settlement charges

1301. Survey.

1302. Pest inspection.

These amounts are added to the cost basis of the property (line 101) and must be depreciated.

Hopefully this gives you a good idea of tax impact of all the items on the closing statement and will assist you if you have purchased or are considering purchasing an investment property.  Please note that these same items have considerably different treatments if purchasing a primary residence or vacation home.  If you have any questions regarding your specific situation, please do not hesitate to contact us.

 

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