Rental Property Acquisition and Closing Costs vs Acquisition Financing Costs - Enter as One Asset or Two Separate Assets?

[GaryS]

For amortization/depreciation purposes on a rental property for the year of acquisition, should you enter the property cost together with associated depreciable closing costs as one asset and then add a second intangible asset for the depreciable acquisition financing costs?   That seems to make sense initially since the acquisition financing costs will have a different useful life (e.g., for a 15 year mortgage, it's 15 years) while the useful life of the rental property itself is set at 27.5 years.  Also, if you end up refinancing the acquisition loan with a different lender a few years later, you could then retire that separate intangible asset that you set up for the acquisition financing costs and take the remaining unamortized portion of those costs as an expense in the year of refinancing without affecting the continued amortization of the property cost asset itself.  Does that all sound correct?

[ColeenD3]

You add all the closing costs to the basis of the purchased building and depreciate that amount as one asset.

[GaryS]

Hi Collen - thanks for your prompt reply, but that approach raises 2 questions:

First, if the acquisition financing costs are included with the property cost and other closing costs, does that mean the acquisition financing costs end up getting amortized over 27.5 years like the rest of the acquisition costs, even if it's a 15 year mortgage? 

Second, I understand that you can expense the unamortized portion of financing costs for a rental property loan when that loan is refinanced with a different lender.  Does that mean that TurboTax will allow you to break out the acquisition financing costs that were bundled into the property basis for the year of acquisition so that you can expense them for the year the loan is refinanced? 

Thanks,

Gary

[ColeenD3]

Normally, it is added to the basis of the property, but it does make it tricky upon refinance. Please see this answer from @Carl.

It depends if you need to actually enter the refinance cost yourself, or if the program does it "for you". I am assuming you refinanced this property while it was classified as a rental, and not while it was your primary residence, 2nd home, or other "personal use" type. Lots of information here. So don't try to absorb it all at once. I'll present it in pieces, so you can deal with it in pieces.

As you know, refi costs are amortized (not capitalized) and deducted (not depreciated) over the life of the loan. So you may first need to deal with your finance cost from the original loan.

- Basically, if you refinanced with a *different* lender, then any remaining financing cost from that original lender are fully deductible on your 2020 tax return. If this is your case, let me know and I'll provide you the property way to do this in the TurboTax program.

- If you refinanced with the same lender, then your financing cost on the original loan are "not" fully deductible in the year you refi with that same lender. You just leave those costs alone and they will continue to amortize over the remaining life span of that original loan, "as if" you did not refinance.

Now, check the list of assets in the Assets/Depreciation section and make sure that the refinancing cost for the "new" loan are "in fact" not there. If they are there, you're done and can stop reading now. Otherwise....

-On the Your Property Assets" screen click the Add an Asset button.

- Select Intangibles, Other Property and continue.

- Select Amortizable Intangibles, and continue.

- Describe this Asset: Enter something like "refinancing loan costs"

- Cost: Enter the total of your refi costs

- Date purchased or acquired: Enter the closing date of the new loan.

- Click continue

- Select that you purchased this asset new, and that it was used 100% for this business. Then enter the closing date of the loan and click continue.

- For the code section, select 163:Loan Fees and then continue.

- Useful life in years is the term of the loan. Typically this will be 15 years or 30 years. Then continue.

- This puts you on the Asset Summary screen. You can see the details here if you like. But you "MUST" click the DONE button on this screen, in order to actually save this entry.

That does it. 

[GaryS]

Thanks Coleen, this helps a lot.

My situation falls under the first bullet in the answer you quoted from @Carl.  Specifically, I refinanced the original acquisition loan on a rental property with a different lender.  According to his first bullet, the remaining financing cost from that original lender should now be deductible. 

He ends that bullet saying "If this is your case, let me know and I'll provide you the proper way to do this in the TurboTax program."   Should I reach out to @Carl for how to do it or is that something you can help me with? 

I don't want to burden you with all the specific detail if you want me to seek out his advice directly.

Thanks,

Gary

[Carl]

The below assumes your loan acquisition costs on the original loan, were entered correctly when the property was coverted to rental, or when you originally purchased the property; whichever occurred last.

DEDUCT FINANCING FEES OF OLD LOAN WHEN REFINANCING

In the Assets/Depreciation section for that rental property, elect to edit/update the entry for your points.

- On the "Review Information" screen click Continue.

- On the "Did you stop using this asset 2021?" screen, click YES.

- On the "Disposition Information" screen, in the disposition date box enter the date you closed on the new loan. Then click Continue.

 - On the "Special Handling Required?" screen, click YES.

- On the "Depreciation Deduction Amount" screen, select Transfer These Fees For Me To Other Expenses. Then click Continue.

You'll see the remaining fees of the old loan to be deducted in the Rental Expenses section, very last screen of that section. The entry will start with "Unrealized Refinancing Fees...."

[GaryS]

Hi Carl – thank you for this very helpful detail.

As background, the property in question was purchased as a rental property several years ago and has been used solely as a rental property throughout the time I have owned it. 

You prefaced your response by saying that the detailed steps you were providing assume that the original acquisition loan costs were entered correctly for the year the property was purchased.

I'm not sure this was correct, but the way I entered the acquisition financing costs was to include them together with the purchase price and other loan closing costs as the original basis for the property and that combined amount has been being amortized over the 27.5 year useful life of a rental property ever since.

Based on the detailed steps you provided following your preface, it sounds to me like that approach wasn’t the correct way to enter acquisition financing costs and that I should have entered them as a separate intangible asset separate from the property and other closing costs, is that right?

If so, is there a way now to reduce the property asset basis currently in TurboTax for this asset by the original financing costs and set those costs up this year as a separate asset noting the year it was put into service (the original purchase date) and then retire it in the year the loan was refinanced?

Thanks,

Gary

[Carl]

Bear with me please, while I re-hash old news. 🙂

Property acquisition costs "are" included in the cost basis of the property and depreciated over 27.5 years.

Loan acquisition costs are "not" included in the cost basis of the property. They are entered as their own physically separate asset which is amortized and deducted (not depreciated) over the life of the loan.

the way I entered the acquisition financing costs was to include them together with the purchase price and other loan closing costs as the original basis for the property and that combined amount has been being amortized over the 27.5 year useful life of a rental property ever since.

I think you meant to say "that combined amount has been being Capitalzed/Depreciated over the 27.5 year useful life "  I'm highly confident you have not been amortizing anything over 27.5 years, but have been depreciating it over that time.

If your loan acquisition costs are "NOT" listed as a separate asset, regardless of weather they're being incorrectly depreciated, or correctly amortized/deducted, then there's really no way to separate them out from the asset being depreciated over 27.5 years. So basically, you have no separate loan acquisition costs remaining to be deducted in the year of the sale.

TO see if this is worth the time/expense of fixing, in what year did you acquire the property, and what were your "loan" acquisition costs? (If you know the loan acquisition costs, you don't have to prove them to me. But if queried by the IRS, you may have to prove it to them.)

Overall, this seems to me to be fixable "as is". But depending on the costs involved, it may or may not be worthwhile on the tax front.

[GaryS]

My apologies for the incorrect terminology.

The property was acquired in 2018 and, for simplicity, the rounded numbers are:  purchase price of $400,000, non-financing closing costs of $5,000, and financing costs of $2,500 on a 30-year acquisition mortgage.

On my 2018 return, I included all those amounts in the basis for the property, so the total basis ended up at $407,500, which is the amount I entered into TurboTax for this asset that is being depreciated over the 27.5 year useful life of the asset.

It sounds like I should have excluded the $2,500 in financing costs and entered them as a separate intangible asset to be depreciated over the 30 year life of the mortgage.  If I had, I could then have followed your steps now to expense the remaining $2,000 of financing costs.

So, given that I did not enter it that way originally, I'm wondering what it would take now to be able to expense the remaining amount of those financing costs.

Thanks,

Gary

[Carl]

The property was acquired in 2018

With $2,500 in loan acquisition costs and the property was purchased in 2018, this will probably be worth it. But I need to know what month in 2018 the property was acquired and placed in service as a rental.

[GaryS]

The property was acquired in July 2018 and put into service as a rental property that same month.

The acquisition financing loan was refinanced with a different lender in February 2020, which means the undepreciated loan costs could have been expensed on my 2020 return.

However, I didn’t realize that I could expense those costs until this year and so they depreciated for the additional year of 2020 as well and the undepreciated amount is now a little lower than it would have been in 2020.

[DianeW777]

You can take the $2,500 and multiply it by the 27.5 year recovery percentage for years 1-3 (2018, 2019, 2020).  Then use the balance as a deduction on your 2021 tax return for the remainder of the refinance costs from the original lender.

Next change the cost basis of the rental property by reducing it by the $2,500 (your number).  It will not affect any of the depreciation going forward because this portion of the asset has been and will be accounted for in 2021. It's not something you will have to remember except for the reason you changed the cost basis of the rental building in 2021.  Keep your records with your tax return.

Lastly, calculate the deduction for 2021 by taking the $2500 minus the depreciation you already used in the prior years. You can enter this as a miscellaneous expense on the rental property with a description.

The 27.5 year chart is provided below to help you with the calculations (add the three years percentages together and multiply by the refinance cost amount).  1.667% + 3.636% + 3.636% = 8.939%

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[GaryS]

Carl - that’s terrific, I’ll follow those steps on my 2021 return and come back to you if I run into any issues doing so.   Thanks so much.  Gary

[mikelipsky]

It's great you bring this topic up because advice everywhere on the internet is to simply and indiscriminately add all closing costs to the basis and depreciate over 27.5 years.  Like you mentioned, the IRS explicitly states in their Rental Property publication that you cannot include in your basis "charges connected with getting or refinancing a loan".  Therefore, Financing Closing Costs should be separated from all other Closing Costs, not added to the basis, and amortized over the life of the loan (typically 30 years).