Can closing costs on the sale of rental property like local taxes, transfer fees paid by the seller for the buyer to close the sale, be deducted against the sale price?

[Carl]

@landlord:

Work through the SCH E rental section "AS IF" you never sold it. 2-3 screens in select the checkbox for "I sold or otherwise disposed of this property in 2017" and keep working it through.

In the Assets/Depreciation section you have to work through each individual asset one at a time. When you get to it, select the option for "YES I STOPPED USING THIS ASSET IN 2017".

Then on the "Special Handling Required?" screen you will select YES.

Also, as working this through, when you get to the screen that shows you the depreciation on that specific asset for 2017, click the "details" button. THen you need to write down the depreciation taken for 2017, and the total of all depreciation taken in prior years.

You must do the above for each individual asset listed in the assets/depreciation section. When done, finish working through the rest of the rental section all the way to the end and click the "DONE WITH RENTALS" button once completed.

Now in the Investment Income section elect to start/update Stocks, Bonds, Mutual Funds, Other and work it through. This will allow you to enter your true cost casis needed for the sale. The cost basis you will enter will be what you paid for the property when you purchased it, plus what you paid for any capital improvments you did to the property at any time after you purchased it.

When asked for depreciation taken, add together all the depreciation amounts you wrote down earlier, to get the total of all depreciation taken on the property while you owned it, and enter that amount.

Now just finish working it through to report this sale.

[Carl]

No. it's not deducted from the sales price. It's added to your cost basis.

Whenever you buy or sell real estate, there are certain expenses associated with the transaction that can be deducted from one’s taxable income. The below lists covers all of these expenses you could potentially be asked for in the TurboTax program.  It also tells you where to get the amount you need. Note that what expenses are deductible depends on the specific transaction. For example, are you the Buyer? Are you the Seller? Is this transaction for your primary residence? Second Home? Rental Property? Raw Land? Did you pay cash? Did you take out a Mortgage Loan? Is the transaction seller financed?

 All of these factors affect what you can or cannot claim as a deduction on your tax return. With the TurboTax program, you’re only asked for those items you are allowed to claim. What you’re asked for, depends on the type of transaction that was performed.

Finally, note that the seller can only claim those items with an amount in the “Paid from seller’s funds at settlement” column.  The buyer can only claim those things with an amount in the “Paid from borrower’s funds at settlement” column.  There is one exception for the buyer. If the seller paid any points on behalf of the buyer, then the buyer can claim the amount the seller paid.

•  Commissions paid at settlement. Line 703 on the HUD-1

• Origination Fees. Line 801.

• Points. Line 802. NOTE: If you have an amount on line 803 and you are NOT asked to enter origination fees and points separately (you’re asked for only one or the other) then you’ll use the amount on line 803.

• Appraisal Fees.  Line 804 on the HUD-1

• Broker’s Fees. This is just another name for “Commissions paid at settlement”. If you look at your  HUD-1 Section L, you’ll see that line 700 is the title of the 700 section, and it clearly labels the 700 line series, “Total Real Estate Broker Fees”.

• Legal Fees. Any money you paid for legal representation.  This is not reported on the HUD-1.

• Advertising Fees. Not on the HUD-1. This is any money you paid to advertise this property for sale. Does not include monies used to advertise this property for rent, or anything else.

• Home Inspection Reports. Any money you paid for a home inspection. This will generally not be reported on the HUD-1.  However, if the buyer’s lender arranged a home inspection and required you to pay for it, then it will be listed on the HUD-1 closing statement in the Additional Settlement Charges section, which begins at line 1300. You can only claim the amount in the “paid from” column that applies to you. Note that a home inspection is not the same as an appraisal. A home inspection report determines the condition of the property. An appraisal determines the value of the property.

• Title Insurance. Line 1102 on the HUD-1

• Transfer Taxes or Fees. Lines 1201-1206 on the HUD-1

• Geological Survey. Sometimes referred to as a property survey. Most lenders require a property survey to have been performed within 2 years preceding the sale. Some 5 years. If a survey was conducted by the lender as a part of this sale, the buyer is usually the one that pays for it. It will be listed on the HUD-1 between lines 1300-1305. You can only claim the amount in the column that applies to you.

• Points paid on the buyer’s behalf. Line 802. Only the amount listed in the “paid from seller’s funds at settlement” column. But special note here. If there is an amount on line 803 in the “paid from sellers funds at settlement” column, then you will use that amount, instead of the amount on line 802 in the “paid from sellers funds at settlement” column.

• Private Mortgage Insurance (PMI) is on line 1003. Add this amount to what's reported in box 4 of the 1098, if you received a 1098 for the same tax year this real estate transaction occurred.

• Mortgage Interest. Line 901 of the HUD-1. Add this amount to the amount in box 1 of your 1098, if you are sent a 1098 for the tax year in which this transaction occurred.

• If you did not make a payment in the tax year the transaction occurred, you will NOT receive a 1098 

All of these items above, when added together, are you total “Sales Expenses” 

• Adjusted Cost Basis: This figure includes what you originally paid for the property, and what you paid for any property improvements you made at any time after you purchased it. It does not matter if you paid for these improvements while the property was a rental, or while it was not a rental. First, we’ll get the original purchase price. Then I will tell you how to get the cost of your property improvements.

  Your original purchase price is on the HUD-1 statement you received when you originally purchased the property. Line 120.

[landlord]

Thanks Carl. I sold rental property in 2017 that was converted from personal use and never converted back. The FMV at conversion was less than the original basis at conversion. I'm assuming my adjusted cost basis ignores the original purchase price and uses conversion FMV as the starting point in determining cost basis at time of sale. Is that correct?

[Carl]

@landlord This is IMPORTANT!!!!!   Do you qualify for the "lived in 2 of last 5 years" capital gains exclusion?

[landlord]

No I don't

[landlord]

I converted it in June 2014, rented through June 2017 and sold in October 2017. I pulled it from the rental market 7/1 and it remained vacant until time of sale with no personal use.

[Carl]

Then for tax purposes, if you never lived in the property for one single day after the last renter moved out, you DID NOT convert the property to personal use. DO NOT convert it to personal use either. Otherwise, you are creating more unnecessary work for *YOU* and significantly increase the possibility of making errors on your tax return that will result in an audit.
Now, since you do not qualify for the capital gains tax exclusion, you can NOT report this sale in the Rental & Royalty Income (SCH E) section of the program. That's because that section can NOT take into consideration the fact that your cost basis is higher than your depreciation basis. You have to report the sale in the Investments section.

[landlord]

What basis should I have put in the system at conversion to begin depreciation? Original cost or FMV at conversion (which was 25k less than cost)? Would it incorrectly calculate the loss on the sale if done in Sch E?

[Carl]

Depreciation of rental property is based on the LOWER of what you paid for it, or the FMV at the time the property was placed in service. But your loss or gain on the property is based on what you paid for it, minus depreciation taken.
Generally for depreciation, what you paid for the property will always be less than the FMV of the property at the time it was placed in service. However, the housing marking crash of 2008-9 makes that statement not true for everyone.

[landlord]

Thanks for your response Carl. Page 4 of IRS Pub ( <a rel="nofollow" target="_blank" href="https://www.irs.gov/pub/irs-pdf/p544.pdf">https://www.irs.gov/pub/irs-pdf/p544.pdf</a> ) discusses a loss on sale of converted property and indicates the loss would be based on FV at conversion if lower than adjusted basis at conversion, which is true in my case. Does your suggested input method in TT get you to that result?

[landlord]

Additionally when I pull up the Investment section in TT it specifically says not to report sales of business or rental property in the "What's not included in this section?". What is the reason for reporting it in the way you describe?

[Carl]

I've been through all this before, several years back. For every rule there are exceptions and things that don't apply, other things that do apply. I'm not going through all that research and back and forth again. I'm just getting to old for it. You report the sale based on what you actually paid for the property plus what you actually paid for property improvements. Now of course, you can report however you want. I'm confident that the IRS will have no issue with you reporting based on the lesser FMV of the property, as that's more of any gain they get to collect taxes on.
You report (in your case) in the investments section, because rental property *is* investment property/business property.
Now if you want to go ahead and report it in the rentals & Royalty Income section (which BTW is what I do since my depreciation values and original purchase values match anyway on my rentals) you most certainly can.
I've seen where some have changed the values in the assets/depreciation section for the asset, and I can tell you that's a sure fire way for an audit 24-36 months down the road. Changing asset values affects not only the current year's depreciation, but it also sticks out like a sore thumb throwing what your depreciation "should" have been in prior years based on the changed value.

[landlord]

I hear you about exceptions to every rule and in my case it appears I ignore the original cost. I found this reg which directly addresses my issue <a rel="nofollow" target="_blank" href="https://www.law.cornell.edu/cfr/text/26/1.165-9">https://www.law.cornell.edu/cfr/text/26/1.165-9</a> Since I sold at a loss I ignore original cost and just use FV at conversion. Otherwise I would be deducting the loss in value that occurred while it was my personal residence which wouldn't make sense.  Unfortunately I had to amend 3 years of returns to correct the basis to FV so I may be getting an audit regardless. Oh well. Thanks for taking the time to work through my issue

[maglib]

@landlord you are correct because it is a loss, personal losses on residential property are never allowed, so that loss on conversion gets ignored.  If it was a gain though, you would take the original cost basis less the depreciation taken for business use.