Help with rental property amortization and depreciation

[Matt_UKTX]

Hello...  I'm in need of some help.  Hopefully one of the experts out there can guide me in the right direction...

I own two rental properties.  One acquired in 2017 and the other in 2019.  Both have always been used as rental properties.  When I originally purchased the properties my CPA (no longer using him) added my closing costs to the cost basis of each property and depreciated them over 27.5 years.  Based on what I have read, I believe that this is incorrect, and some of the closing costs (those tied to the loan and not the property - such as points) should have been added as an "intangible asset" and amortized over the life of the loan (15 years).  

Flash forward to 2021, I refinanced both properties.

When I refinanced, I created two assets for each property, one for the property related closing costs (title fees, settlement fees, etc.) amortized over 27.5 years and another for the loan related closing costs (points, appraisal fees, etc.) amortized over 15 years.  However, I now believe this was incorrect, and the property related closing costs should just have been added to the property's cost basis.  I couldn't figure out how to do that at the time, but I think the correct way is simply to go to the property and add that amount to the field marked "cost", rather than creating a new asset for it amortized over 27.5 years.

I'm not too worried financially, as the tax implications of these changes are minimal (if any) but I would like things to be correct so I don't run into any problems down the road.

My questions are as follows:

- What should I do about the initial error by the CPA when I bought the properties in 2017 and 2019?  Do I need to go back and figure out which closing costs should have been depreciated (27.5 years) and which should be amortized and then make the changes in Turbo Tax? I don't think it will make a material difference, and I am not excited about the possibility of filing 6 amended tax returns.  Advice here would be welcome.  I believe any financial change would be in my favor, not the IRS.

- If I do the above, I am assuming those purchase loan expenses amortized over 15 years would have to be fully amortized on my 2021 return when I did the refi.  I would then create a new asset amortized over 15 years for the refi (different lender).

- Can someone please confirm my understanding of the difference between items added to cost basis, vs amortized over the life of the loan (15 years) vs amortized over 27.5 years?  When acquiring a new property (as opposed to refinancing), am correct in thinking that only those associated with the property are added to the basis, and the others are added as an asset to be amortized over the life of the loan.  I'm about to buy a third property and want to set things up correctly from the start this time.  

Any help or support would be much appreciated 🙂

Thanks,

Matt.

[Mike9241]

the CPA messed up.

Loan expenses are amortized over the life of the loan. Expenses like, appraisal fees *if* required by the bank in order to secure the loan, as well as what the bank calls "origination fees" which may or may not include points. these are amortized over the life of the loan.

Whereas expenses incurred in acquiring the property are capitalized as part of its cost. then the total cost usually needs to be allocated between land (not depreciable) and building depreciated over 27.5 years. These would include such items title fees, title insurance and things like documentary stamps..

to correct the CPA's  error in the current year's return would require filing form 3115. 

here's a link to what Turbotax says about refinancing rental property:https://ttlc.intuit.com/turbotax-support/en-us/help-article/tax-credits-deductions/deduct-refinancin... 

here's what it says

Unlike your primary residence, where you can only deduct qualified points and interest, you can deduct all costs associated with obtaining a new mortgage for your rental property. Typical loan-related expenses include:

• Points
• Loan origination and loan assumption fees
• Mortgage insurance premiums
• Application fees
• Credit report fees
• Appraisal fees (if required by the lender)

The costs associated with obtaining a mortgage on rental property are amortized (spread out) over the life of the loan. For example, if it cost you $3,000 to refinance your 30-year mortgage, you'd be able to deduct $100 per year for the next 30 years.

notice the items in bold contradict one another 

my understanding is that for rental property

the same rules apply to the refi.  loan expenses are amortized over the life of the new loan with the unamortized balance of loan expenses on the old loan written off. 

there is another Turbotax thread about refi of rental property that contradicts the above Turbotax thread.

https://ttlc.intuit.com/community/tax-credits-deductions/discussion/re-can-you-continue-to-amortize-... 

same lender: the remaining unamortized balance of loan expenses gets amortize over the life of the new loan. (I know this rule applies to a personal residence but I was unable to find confirmation this applies to rental) 

wait to see how others respond. 

[Critter-3]

In the year of purchase you can add up the total cost basis for the rental for depreciation ... purchase price + cost to buy + improvements made before the place was rented = total cost basis which will be divided between the land and the structure.

Refinancing costs later must be amortized over the life of the loan ... follow the interview screens carefully to enter them. 

[Matt_UKTX]

So, it looks like I need to file Form 3115 to correct the error from the previous CPA, adjusting the depreciation and creating an amortization for the "loan fees" that were incorrectly added to my basis.  I expect the impact to be minimal, but better to make sure it is correct.

I have a question on my refi...  When you refinance the property, I understand that loan expenses (appraisal fees, credit report, points, etc.) are added as a new asset and amortized over the life of the loan (15 years in my case).  I also understand that costs related to acquiring the property (title fees, etc.) are added to the "basis" of the property to be depreciated over 27.5 years.

Here is my question... How do you "add to the basis" of a rental property in turbo tax years after it has been placed in service?  Do I simply create a new asset, place it in service as of the refi date, and amortize it over 27.5 years (just like I did with the loan costs) OR do I go into the rental property details, and just manually add the amount to the "Cost" field?  If I do the latter, the added amounts will not be depreciated over 27.5 years, but over the remainder of the 27.5 years since the property (not the refi) was placed in service.

Thanks...

[Carl]

On a refi, the only thing you will add in the assets/depreciation section is points to be deducted over the life of the loan. Nothing else. Since the original loan was only 2 years ago, I myself wouldn't worry about the past. But that's me.

here's how to enter the points in the Assets/Depreciation section.. (does not apply to entering the property itself, or any other property assets.)
- Select the Add and Asset button. (go straight to the asset summary if presented that option)
- Select Intangibles/Other Property, then continue.
- Select Amortizable Intangibles, then continue.
- Describe it as something like "2021 Financing Fees".  Then enter the amount, and the closing date of the loan. Then continue.
- Select "purchased new", then "100% business use", enter the closing date of the loan (again), then continue.
- Code section is 163:Loan Fees, then continue.
- Useful Life in Years is the length of the loan, then continue.
- You can "show details" if you like. Then continue, and that does it

[Matt_UKTX]

I'm not sure this is correct for a rental property.  You can amortize/depreciate much more than just the points paid.  Per IRS Publication 551 (https://www.irs.gov/pub/irs-pdf/p551.pdf) you can amortize the following over the life of the loan:

Charges connected with getting a loan. The following are examples of these charges.

a.Points (discount points, loan origination fees).

b.Mortgage insurance premiums.

c.Loan assumption fees.

d.Cost of a credit report.

e.Fees for an appraisal required by a lender

Then in addition you add the cost of these items to the "basis" for the property:

- Abstract fees (abstract of title fees).

- Charges for installing utility services.

- Legal fees (including title search and preparation of the sales contract and deed).

- Recording fees.

- Surveys.

- Transfer taxes.

- Owner's title insurance.

- Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.

My question at this point is just how do I add these to the basis in Turbo Tax.  Do I create a new asset and amortize it over 27.5 years, OR do I simply go into my property (already listed from previous years) and adjust the cost by the dollar amount of these items?

Thanks,

Matt.

[Carl]

Expenses associated with acquisition of the property are capitalized and depreciated over time. If this is a refinance, then there will not be any of these expenses. Examples include title transfer fees, sometimes referred to as documentary stamps.

Expenses associated with acquisition of the loan are amortized and deducted (not depreciated) over the life of the loan. Examples would include points paid at closing as well as survey fees if a survey was required by the lender as a condition of loan approval.

[Matt_UKTX]

I still do not think that is correct.  When you refinance a home, there are still fees that are incurred, like these:

- Legal fees (including title search and preparation of the sales contract and deed).

- Recording fees.

- Surveys.

- Owner's title insurance.

They apply on a refi just as the would on a new purchase.  You have to get a new title policy if you have owned the house for more than a few years.

Are you saying they ALL get amortized over the life of the loan, as opposed to some being added to the basis (and depreciated) versus some being amortized?

[Carl]

They apply on a refi just as the would on a new purchase.

But they are not paid for you to "acquire" a property you already own and acquired at some time in the past. I "think" this is covered in Pub 930, but might be 936.

[tagteam]

@Matt_UKTX 

See https://www.irs.gov/publications/p551#en_US_202212_publink1000256910

[Matt_UKTX]

Thanks, I've read this publication a few times, however I still don't understand the steps in Turbo Tax to "increase my property's basis".  

Do I:

A) Edit the property itself, and adjust the cost basis manually, causing the additional amounts to be depreciated over whatever is left of the original 27.5 year usable life OR...

B) Create another asset called for the amount in question, and amortize it over 27.5 years from the date of the refi?

To be clear, I am not talking about costs associated with the loan here.  I'm talking about those associated with the property - like title fees, etc.

Or is there an option C) Since all the costs are actually caused by the act of refinancing (as opposed to a purchase), you can amortize the entire closing costs over the life of the loan, without worrying about what is related to the loan vs the property.

Am I making any sense?

[tagteam]

There are certain costs (charges) that you can neither add to your basis nor deduct (or depreciate/amortize).

See https://www.irs.gov/publications/p936#en_US_2022_publink1000229953

[Carl]

You state this is a refinance of a real estate loan. You only have loan acquisition costs that are amortized and deducted over the life of the loan. You do not have any deductible real estate acquisition costs, because you can not acquire real estate that you already own.

If you change the cost basis of any asset listed in the assets/depreciation section of the SCH E, three things will happen.

1) The record of all prior year's deprecaition already taken will be changed by the program and therefore it will be wrong.

2) The current year's depreciation will be wrong

3) All future year's depreciation will be wrong.

All of that will come back to bite you in the tax year you sell or otherwise dispose of the property.

[Matt_UKTX]

Carl,

That makes sense, but at that point aren't ALL costs associated with closing a refi considered "loan costs" since you cannot get the loan without them, and therefore should be amortized over the duration of the loan (apart from expenses like interest, prepaids, etc.). 

Specifically, how do you account for these things on a refi?

•  Abstract fees (abstract of title fees).

•  Legal fees (including title search and preparation of the sales contract and deed).

•  Recording fees

•  Surveys. 

•  Owner's title insurance.

Surely you must be able to either expense them, depreciate them or amortize them in some way, since this is a rental property and a business asset?

[Carl]

If it was a condition of loan approval/loan acquisition, then it's amortized and deducted over the life of the loan.