Treatment of Closing Costs and Other Fees

The most frequently asked question when people buy and sell property is "Which closing costs are deductible?". If you look at a closing statement, commonly called a HUD-1, you will see plenty of itemized costs. Unfortunately the only items that are currently deductible
are property taxes (but only those actually paid/credited, escrow doesn't
count), mortgage interest, and in the case of a rental or business property
association dues or other fees that would normally be deductible if invoiced and
paid apart from closing.

The remaining costs are split into three groups: land,
building and loan costs. The building is depreciated (27.5 years for residential
rental, 39 years for other commercial property) and the loan costs are amortized
over the expected life of the loan (we usually use five years). You get no deduction for the land on the theory that it does not deteriorate in value so it's cost should not be recovered as a tax deduction. Here are some areas you should be aware of when trying to optimize tax deductions.

1. The allocation between building and land. If the property is a rental or commercial real estate you will get a depreciation deduction on the building. However, your allocation of the purchase price must be reasonable. If you buy a beach front property with a 50 year old bungalow on it allocating 80% of the cost to the house is a stretch. Property tax records, appraisals and insured values can all point you in the direction of a sound allocation.



2. Classification of loan costs as closing costs. There are many costs required by the lender apart from doc stamps and title fees. If these are not classified as loan costs they will be allocated to the building with a much longer depreciation period or land with no depreciation deduction at all.



3. Identification of intangible taxes paid on the mortgage. These are deductible when paid (at closing). Failure to pull them out most often results in their classification as loan or closing costs.



4. Failure to treat property tax credits properly. A seller in a county that taxes in arrears will often be charged an amount for property tax through the date of sale. This is a tax deductible expense. The buyer will receive a property tax credit at closing and must deduct this from the amount of taxes actually paid during the year to arrive at the proper tax deduction.



5. Failure to seperately account for included goods and furnishings. There are several reasons to write furnishings up as a seperate bill of sale, but one of the biggest it quicker write-offs for furnishings vs. the building itself.



6. Failure to properly amortize or deduct points. Depending on the type of loan and the use of the property you may be able to immediately deduct an points paid. Alternatively they should be amortized over the actual life of the loan. If you refinance make sure any unamortized points are deducted in the same way loan interest is accounted for.

Closing statements can get confusing when it comes to segregating tax deductible items from those that should be capitalized. If you have questions don't be afraid to ask someone who has experience optimizing these transactions to bring the greatest tax benefit.

Joey Brannon is the founder of Axiom Professional Group, a tax, consulting and accounting firm in Bradenton, Florida. Mr. Brannon is both a CPA and an EA. You can find out more about Axiom by visiting www.axiomcpa.com.