I refinanced my house in 2021 and rented it in 2022. Can I use the refinance cost for 2022's tax deduction in Schedule E?

[wleuter]

I refinanced my house in 2021 and rented it in 2022. Can I use the refinance cost for 2022's tax deduction in Schedule E?

Thanks!

[Opus 17]

What refinance cost?  What tax deduction?

I will comment on two issues you might be asking about.

1. Depreciation.

When you place the house in service as a rental, you must list the value for depreciation.  You depreciate the property over 27.5 years.  The larger the value you can list for depreciation, the more of a deduction you take each year.

The value you use for depreciation is either:

a. your adjusted cost basis, or

b. the present fair market value, whichever is less,

Then you subtract the cost of the land (since land does not depreciate).

Adjusted cost basis is the original purchase price, plus the value of permanent improvements (but not repairs).  Some of the closing costs associated with the original purchase and the refinancing can be added to the adjusted cost basis, but probably not all the closing costs.  Items that can be used to adjust the cost basis are listed in publication 523 on page 8.  

https://www.irs.gov/forms-pubs/about-publication-523

For example, suppose the house cost $100,000, your original closing costs were $3000, closing costs on the refinance were $4000, and the portion of the original purchase price attributed to the land was $15,000.  The basis you list for depreciation is ($100,000 minus $15,000 plus $7,000)= $92,000.

2. Mortgage Interest expenses

Your monthly mortgage interest expense is one of the expenses you can deduct from your rental income.  You can also deduct insurance, utilities, and property taxes that you actually pay.  You can't deduct your entire mortgage payment, because you can't deduct the principal part of the loan and you can't deduct escrow amounts (only the amounts actually paid to the insurance company, property tax department, etc.).  You can deduct mortgage interest on a property that you rent out even if the mortgage is more than $750,000 (which makes it not fully deductible on schedule A if it was still your personal home).

If you are asking a different question, please provide more details. 

[wleuter]

@Opus 17 

Thanks for your answer!

What I mean is the refinance closing cost for the depreciation of my house which you already mentioned in your answer.

I noticed not all the closing cost I can use for the depreciation. Below are the numbers TurboTax asked me to fill for the original closing cost. So for the refinance closing cost, should I just follow the same rule to calculate the cost I can use for the depreciation?

Thanks!

[Opus 17]

@wleuter 

Here I am going to admit some ignorance.  I did some research, and I think I have to go against my prior answer, and refinance costs don't adjust the basis.  But there is a point that I am uncertain about.  I will paste below what the IRS says in publication 551 Basis of Assets.  

Essentially, costs of buying a property that you would have to pay even if you paid cash are adjustments to basis, but closing costs associated with obtaining a mortgage are not.  So things like abstract and title fees and other required legal fees are includable.  Later, it says that refinance charges are not includable in the basis.  But, a refinance often includes a fresh title search and other legal fees, as required by the second bank.  So I am really not sure if those fees would be includable or not.  My guess is not, because they weren't "costs you paid to acquire the property even if you paid cash", since you already owned the property.

Even later, the IRS says that refinance costs are amortized over the life of the new loan (1/30th per year for a 30 year mortgage, for example).  But you didn't refinance a rental property, you refinanced a personal home that you later turned into a rental.  So I don't think you can argue the refinance was business related, unless the refinance was clearly part of a plan you made to turn the home into a rental (such as, you needed to change the terms of the mortgage to allow it to be rented out).   If the refinance was business related, I don't know where in Turbotax you would enter those amortized refinance costs.

https://www.irs.gov/publications/p551

Settlement costs.

Your basis includes the settlement fees and closing costs for buying property. You can't include in your basis the fees and costs for getting a loan on property. A fee for buying property is a cost that must be paid even if you bought the property for cash.

The following items are some of the settlement fees or closing costs you can include in the basis of your 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.

Settlement costs don't include amounts placed in escrow for the future payment of items such as taxes and insurance.

The following items are some settlement fees and closing costs you can't include in the basis of the property.

1. Casualty insurance premiums.

2. Rent for occupancy of the property before closing.

3. Charges for utilities or other services related to occupancy of the property before closing.

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

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

   2. Mortgage insurance premiums.

   3. Loan assumption fees.

   4. Cost of a credit report.

   5. Fees for an appraisal required by a lender.

5. Fees for refinancing a mortgage.

If these costs relate to business property, items (1) through (3) are deductible as business expenses. Items (4) and (5) must be capitalized as costs of getting a loan and can be deducted over the period of the loan.

[wleuter]

@Opus 17 

Thank you very much for your answers!

[Opus 17]

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@wleuter wrote:

@Opus 17 

Thank you very much for your answers!

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I should probably tag @Carl in case he has something to add about residential rentals.

[Carl]

Basically, if you itemized deductions on your 2021 return and claimed your costs, you can't claim them again on your 2022 return at all. You'll need to check your 2021 return, but most likely you did not itemize deductions on your 2021 tax return. Just look at line 12a of the 2021 return. If the amount entered there is from SCH A, then you itemized. But chances are, you did not itemize and instead took the standard deduction.

Here's the explanation of your deductible refinancing costs.

 - Those cost related to acquisition of the property are added to the cost basis of the property and depreciated over time. Since this is a refinance with no change in ownership, you do not have any costs associated with acquisition of the property.

 - Those costs associated with acquisition of the loan are amortized (not capitalized) and deducted (not depreciated) over the life of the loan. If correctly entered, they will appear in the Depreciation/Assets section of the SCH E as a separate item, labeled something along the lines of "financing costs" or similar.

[wleuter]

@Carl 

Thank you very much for your answers! They are really helpful!

For the costs below, I couldn't find where I can input them in TurboTax Premium Online version. Do you know where I can find it? Thanks again!

Those costs associated with acquisition of the loan are amortized (not capitalized) and deducted (not depreciated) over the life of the loan. If correctly entered, they will appear in the Depreciation/Assets section of the SCH E as a separate item, labeled something along the lines of "financing costs" or similar.

[Carl]

In the Rental property section for the property, elect to start/update assets/depreciation. Select to go straight to your asset summary if prompted.

Select "Add an Asset" button.

Select Intangibles, Other Property and continue.

Select Amortizable Intangibles, continue.

For description, enter something like "Financing Fees'.

Enter the total amount of your loan acquisition fees.

Enter the date you closed on the loan, then continue.

Select None of the Above, then select that you've used it 100% for business, then enter the date you converted the property to a rental, or the date you closed on the loan: WHICHEVER IS LAST! and continue.

For Code Section, select 163: Loan Fees, then continue.

For Useful Life in Years, enter the length of your loan. Typically it's either 15 years or 30 years. Then continue.

You can view details if you like, but you're basically done once you click the continue button.

[wleuter]

@Carl 

Thank you very much!