Rental Property Closing Costs: Basis, Loan Fees and Land Split

Which lines on a rental closing statement are basis, loan costs or expenses?

Sort every line of the final settlement statement (your closing statement or Closing Disclosure) into one of four places: the property's cost (its basis), the loan's cost, an expense of owning the rental, or money that is only held or moved. Most buying costs are not deducted in the year paid: they add to basis. Loan costs are generally deducted over the loan, and your own prorated expenses are rental expenses. Publication 551 gives the test for the property's cost: a fee for buying the property is one you would pay even if you bought it for cash. Fees for getting a loan are not part of that cost.

A case is not simple if:

• you lived in the home before renting it, or still live in part of it;
• the unit was not ready for rent at closing, so some costs fall before rental expenses start;
• the statement has a seller credit, a fee you cannot place, or a mortgage-related fee the two IRS publications word differently;
• the property is held in an LLC, with a partner, or by a partnership;
• the property comes with tenants, so the statement credits you their security deposits or prorated rent, and a preparer should confirm how the rent credit is reported;
• the seller is a foreign person, so the buyer may have to withhold tax from the seller's proceeds (see "Different for you?");
• the closing was in an earlier year and was never entered in the books, and a first Schedule E, a lender, an LLC or a partner now needs the numbers.

Gather the final settlement statement (not a draft), the deed, the county tax assessment and tax bill, the loan papers, the insurance bill, and receipts for work done before renting.

A wrong sort repeats every year: a loan fee added to the building is depreciated over 27.5 years instead of the loan term, and a land share put on the building is depreciated when it never should be. It also carries into the gain when you sell. If the closing was in an earlier year or a first Schedule E, a lender, an LLC or a partner is coming, the opening entries come first; see "Different for you?" at the end of this page.

Which settlement fees add to basis, and what about inspections and appraisals?

Fees you pay to acquire the property add to its basis: legal fees (including title search and preparing the contract and deed), abstract fees, owner's title insurance, recording fees, surveys, transfer taxes and charges for installing utility services. So do amounts the seller owed that you agree to pay, such as back taxes or interest, charges for improvements or repairs, and sales commissions (Publication 551; Publication 527).

These costs are not deducted in the year paid, even if you plan to live in the property first and rent it later. The building part is recovered through depreciation. The land part comes back when you sell.

Inspections and appraisals. Publications 527 and 551 do not list inspection fees among the costs of buying. The Treasury regulation on acquiring property does: it names inspection and survey services pertaining to a particular property, and securing an appraisal to determine value or price, as costs that must be capitalized, and its example is a termite inspection and an environmental survey (26 CFR 1.263(a)-2). For a rental you buy to rent, an inspection fee or an appraisal you order for yourself is therefore likely basis. If you plan to live in the home first, the publications do not say whether that rule applies: keep the invoices and have a preparer decide. An appraisal the lender requires is a loan cost (Publication 551).

Some lines are named on neither IRS list or are worded differently. Until a preparer confirms, handle them like this:

Which closing costs belong to the loan, and how are they recovered?

Costs of getting the loan are not added to the property's basis. Publication 551 names points and loan origination fees, mortgage insurance premiums, loan assumption fees, a credit report, a lender-required appraisal and refinancing fees. For business property, a credit report and a lender-required appraisal are recorded as an asset and deducted over the loan period, and the regulations treat other costs of arranging the borrowing the same way, as extra discount on the loan (26 CFR 1.446-5). Publication 551 calls premiums and assumption fees business expenses without a timing rule, so a preparer sets those.

Points are prepaid interest. Publication 527 says to deduct them over the loan term, not in the year paid. It allows straight line and other methods only when the total discount is small: the points plus other loan costs counted as discount stay under 0.25% of the loan amount for each year of the term. For a loan repaid in installments, the regulation counts the average time until principal is repaid, not the full term (26 CFR 1.1273-1(d)), so a preparer should run the test from the repayment schedule. The method is chosen by deducting that way on the timely filed return for the year the loan is made. Otherwise a constant-yield method applies (a yearly schedule a preparer usually sets up). The Schedule E instructions agree: points charged only for the use of money are deducted over the life of the loan.

If the loan is paid off or refinanced later, the unused points may be deductible that year, with exceptions for a refinance with the same lender and for refinanced money not used for the rental (Publication 527). A preparer sets that up.

In the books, keep one asset account of loan costs per loan and release a slice into expense each year, with points alongside mortgage interest. The Schedule E instructions and Publications 527 and 551 name no line for the yearly slice of other loan costs, so a preparer sets it. Points on a main home follow a special rule; see the section on living in the home first.

How do property tax prorations on the statement work: the seller's share versus mine?

The county's tax for its tax year is split by day at the closing date. The days before closing belong to the seller, and the days from closing day on belong to the buyer, whether or not the statement apportions the tax that way (26 U.S.C. 164(d); 26 CFR 1.164-6). The county's tax year may not be the calendar year; the regulation's own example runs April to March.

Delinquent tax from an earlier tax year is not split between buyer and seller (26 CFR 1.164-6); if you agree to pay it, it is basis.

Your own share is a rental expense on the taxes line of Schedule E, for the days the property is held for rent. For days before the unit is available for rent, see rental expenses before the first tenant.

How do I enter prepaid insurance, escrow deposits, HOA proration and prepaid interest?

Each of these is something you paid at closing for a future period or for the lender to hold. Book it first as an asset or as the right expense account, then release it as the period passes.

A one-time fee the association charges at closing, such as a capital contribution or transfer fee, is not addressed by Publications 527 and 551. Keep the invoice and have a preparer classify it.

How much of the price is land and how much is building?

Divide the total cost between land and building by the ratio of each one's fair market value to the whole property's fair market value at purchase. If you are not certain of those values, use the county's assessed values for real estate tax (Publication 527; Schedule E instructions). The land share is never depreciated.

1. Start with the total cost: the price plus the buying costs that are basis. Leave out the loan costs.
2. Check the contract. For several assets bought for a lump sum, Publication 551 says an allocation in the sales contract is generally accepted when it is based on value and buyer and seller have adverse tax interests. The sample rental purchase in Publication 527 starts from the contract's land and building amounts.
3. If the contract is silent, use fair market value: the price at which the land and the building would change hands between a willing buyer and a willing seller who both know the relevant facts (Publication 527). Keep any appraisal.
4. If you are not certain of fair market value, use the assessment: divide the land's assessed value by the total assessed value and apply that share to the total cost.

The assessment is a fallback. If you have better evidence of fair market value, a preparer should decide which to use. The IRS publications set no fixed land percentage. If the county bill shows only one total value, ask the assessor's office for the land and improvement split, or get an appraisal that shows it.

If the purchase includes appliances or furniture, allocate part of the price to them even when the contract gives one lump sum (Publication 551), and take that part out of the building share. They are depreciated separately over 5 years (Publication 527). A special depreciation allowance of 100% may apply to them if acquired and placed in service after January 19, 2025, unless you elect out; the building does not qualify (Publication 946, chapter 3). The election covers a whole class of property placed in service that year, on a statement attached to the timely filed return, extensions included, for that year. A partnership makes it for its own property. A timely filer who missed it can make it on an amended return within 6 months of the original due date (same publication). Settle that before the first depreciation is booked. Do the split once, at purchase, and keep the work: every later year of depreciation rests on it.

Can I deduct closing costs if I live in the house first, or still live in part of it?

The fees you pay to buy the property are basis, not deductions, whether you live in the home first or rent it first. Other lines follow their own rules: your share of property tax and interest, and points on a main home. When a home becomes a rental, the depreciation base is the lesser of its adjusted basis and its fair market value on the date of the change, with the land share left out (Publication 527). The fees you paid to buy the home are already part of its adjusted basis.

• Adjusted basis is the original cost, plus permanent improvements, minus casualty losses claimed and other decreases. Fair market value is measured on the date of the change and split between land and building.
• The date of the change is the placed-in-service date. Yearly costs such as taxes and insurance are divided between the personal and rental parts of the year, and there is no depreciation or insurance deduction for the personal period. Mortgage interest and real estate tax for that period may be deductible on Schedule A instead.
• Points paid when you bought a main home follow home-mortgage rules (Publication 551). If the home later becomes a rental, Publications 527 and 551 do not say what happens to any remainder, so a preparer should handle it.

If you rent only part of the home, such as one half of a duplex, Publication 527 says to divide certain expenses between the rental and personal parts as though you had two separate properties, by any reasonable method such as rooms or square footage. It does not say how to divide the purchase price: have a preparer settle that split before the first depreciation, with bookkeeping help. For day counts when you also use the home, see fair rental days and personal use.

What do I record on closing day, and how do I tie it to the bank?

Make one closing entry. Debit each asset and expense the statement bought, credit the mortgage for the loan amount, and credit the bank only for the cash you paid.

With no loan, drop the mortgage line and credit the bank for the full price plus costs. If the unit is not available for rent at closing, or you lived in it first, do not expense the property tax, dues and interest lines on closing day: hold them in a separate account for the property and let a preparer decide where they go; see rental expenses before the first tenant.

Tag every line to the property; see setting up accounts for rental property.

To tie the entry to the bank:

1. Start with the total due from you on the final statement. The closing debit in the bank should match it.
2. Move anything paid earlier into the purchase accounts instead of recording it twice: earnest money, and any fee paid by card before closing, which may show on the statement as already paid.
3. If the entry and the bank disagree, look for a line paid outside closing, earnest money counted twice, or a refund from the closing agent that lowers the account it was overcharged to.

When does depreciation start, and how long does it run?

Depreciation starts on the date the building is ready and available for rent, even with no tenant. That is not the first-lease date, and it is not the closing date if the unit still needs work. A residential rental building is depreciated over 27.5 years by the straight line method (Publication 527; Publication 946).

• Mid-month convention: the building is treated as placed in service in the middle of its month, so that month gets half a month of depreciation (Publication 946).
• Land: never depreciated (Schedule E instructions).
• Where it goes: the depreciation line of Schedule E, with Form 4562 attached for property first placed in service that year (same instructions). A partnership reports it on the depreciation line of Form 8825 (instructions).
• System and building type: the general depreciation system applies unless the law requires the alternative system or you elect it; an election for a residential rental building is made in the first year it is placed in service and can never be revoked (Publication 527). The alternative system, a mostly commercial building and a hotel-like unit each use a longer period (Publication 946).

If the unit was not yet ready and available for rent at closing, depreciation starts when it becomes ready and available; see rental expenses before the first tenant. Costs of work done before renting go there and to repair or improvement for a rental.

What should I keep from closing?

Keep the closing statement and the papers behind each line for as long as you own the property, and until the period of limitations ends for the year you sell it. Publication 583 says asset records should show when and how you acquired the property, the purchase price, the cost of improvements and the depreciation taken, and it names real estate closing statements and canceled checks as proof.

• The final settlement statement (not a draft), the deed and the bank record of the closing wire.
• The county assessment and the purchase-year tax bill, which support the land split and the tax proration.
• The loan papers, which show which charges are loan fees.
• The appraisal, the inspection report, the insurance bill and the association statement.
• Receipts and dates for work done before renting, and proof of the date the unit was ready for rent: the listing, dated photos, the first lease.

For landlord records in general, see rental property records and receipts.

Example

All figures are in US dollars and are illustrative.

Sorting a duplex closing

An owner buys a duplex for US$400,000 with US$80,000 down and a US$320,000 30-year loan. The statement shows US$4,000 for title and legal, US$1,500 for recording and transfer taxes, US$3,000 in points and US$600 for the lender's appraisal.

• Basis: title, legal, recording and transfer taxes add US$5,500. Total cost is US$405,500.
• Loan costs: points and the appraisal are US$3,600. The loan has level payments. For a 30-year loan like this, US$3,600 is well under the de minimis limit, so straight line (equal amounts each year) is allowed: about US$100 a year for the points and US$20 for the appraisal fee.
• Cash to close: US$80,000 down plus US$9,100 of closing costs is US$89,100.
• Closing entry: debit land and building US$405,500 and loan costs US$3,600; credit mortgage payable US$320,000 and bank US$89,100. Debits and credits both total US$409,100.

Splitting land and building, then starting depreciation

The contract does not split the price and the owner has no appraisal, so the owner uses the county assessment: land US$100,000 and building US$300,000, or 25% and 75%. Applied to the US$405,500 cost, land is US$101,375 and the building is US$304,125.

The duplex is ready and available for rent on closing day in February. Using the first-year rate for February in the Publication 527 table, 3.182%, depreciation is about US$9,677. Each full year after that uses 3.636%, about US$11,058. Had the whole US$405,500 gone to the building, depreciation would run about US$3,226 too high in the first year and US$3,686 too high in each full year after.

Property tax at closing

Take a different rental, available for rent from closing day. The county bill for the tax year is US$2,000 and is unpaid at closing. Closing falls 60% of the way through that tax year (a county's tax year need not be the calendar year), so the seller's share is US$1,200 and the buyer's is US$800. The buyer pays the bill at closing.

• With no credit from the seller, the buyer's payment of the seller's US$1,200 adds to basis.
• If the seller credits the buyer US$1,200 on the statement, the credit covers it and nothing is added to basis.
• The buyer's US$800 is property tax expense for the rental.

Different for you?

• You closed in an earlier year and never entered the statement or split land from building, and a first Schedule E, an LLC, a partner or a lender's request is coming: the opening entries fix the land and building split, the depreciation start date and the loan-cost schedule for every later year. Rebuild them with bookkeeping help; see also catching up on rental property books.
• Earlier returns used a wrong base, or depreciation was never taken: how earlier years are corrected depends on what went wrong; see missed depreciation on a rental.
• A lender wants statements for the rental: see a rental profit and loss for a lender. The opening entries must be in place first; if they are not, see bookkeeping help.
• The rental sits in an LLC or has several owners: see rental property in an LLC. A partnership reports rentals on Form 8825, not Schedule E.
• The building is mostly commercial, or a hotel-like establishment: the recovery period of 27.5 years may not apply, so have a preparer set the period and the books with bookkeeping help.
• The seller is a foreign person: the buyer must generally withhold 15% of the amount realized (in most cases the price) from the seller's proceeds, unless the seller gives a certification of nonforeign status (a signed Form W-9 counts) or an exception applies, and report it on Forms 8288 and 8288-A within 20 days of the transfer. A buyer who does not withhold may be held liable for the tax (IRS: FIRPTA withholding; Form 8288 instructions). Ask the closing agent what was withheld, and keep the certification or withholding papers with the closing statement.
• You live outside the US, or you are a Canadian with a US rental: the filing and treaty questions are in Canadians with US rental property.
• You got the rental by inheritance, as a gift or in a like-kind exchange: basis may not start from a purchase price (Publication 551), so have a preparer set the opening basis with bookkeeping help.
• You plan to sell: the basis you set now drives the gain later; see selling a rental and depreciation recapture.
• You need rental income, Schedule E and passive loss rules: see rental property taxes.