Discussion:Personal Residence Converted to Rental

What about the other costs incurred when the property was purchased (loan fees, closing costs, etc.) -- can we amortize them as well starting 09/01/08?

She also refinanced this house one time back in 2005 --just to lower the interest rates, no cash out. Can we amortize the refinance costs (closing costs, loan fees, etc.) as well starting 09/01/08?

Thanks.

I have asked various tax practioners over the years what they do, and some say yes, basis, others say no, lost costs, and others say, if the amount is not too large, add to basis and let the IRS figure it out if there is an audit.

What I have started doing with rental property refi's (I know, this is a different animal from your question) is add up the "loan costs", including points of course, and amortize over the life of the loan, writing off the balance if refied later. I call these "refi loan costs" on the depreciation schedule.

Then I get all of the other costs, escrow fees, title charges, etc., lump these together and call them "refi costs" on the depreciation schedule, then deduct them over the property life (27.5 for residential rental). I do NOT write off the balance if there is a subsequent refi.

Anyone do this differently?

For the residence converted to rental real estate:

Add up your basis in the home from original purchase including closing costs when purchased (omit points or origination fees, funds placed in escrow accounts, hazard insurance cost, credits for prorated property tax or repairs), add improvements (not repairs) over the years, closing costs for refinancings (same list of what not to include). This is your total cost basis. Compare to fair market value at 9-1-2008 which is your limit for basis to show on date of conversion. Split this amount into a value for the land and the home. Depreciate home over 27.5 years with in service date of 9-1-2008.

Allocate mortgage interest, hazard insurance and property taxes for year 2008: 8 months to personal use period and 4 months to rental property period.

Look at original purchase or any later refinances - determine if included points or origination fees (must be percentage of loan amount to qualify) - only these costs of getting a loan represent interest charges over the term of the loan. If they were expensed at purchase there is no amount left to amortize. Any amounts not expensed should have been amortized to residential mortgage interest over the period of the loan. Calculate the unamortized balance of these charges at the conversion date of 9-1-2008 and set up to amortize over the remaining term of the loan. This interest charge was in effect prepaid and now applies to the use of the building as rental property. Don't forget to put the first 8 months of 2008 on your schedule A when it applied to the residence use time period.

The other costs of getting earlier loans must be treated as cost basis since the loan was not secured on a business use asset.

Your words: What I have started doing with rental property refi's (I know, this is a different animal from your question) is add up the "loan costs", including points of course, and amortize over the life of the loan, writing off the balance if refied later. I call these "refi loan costs" on the depreciation schedule. Then I get all of the other costs, escrow fees, title charges, etc., lump these together and call them "refi costs" on the depreciation schedule, then deduct them over the property life (27.5 for residential rental). I do NOT write off the balance if there is a subsequent refi.

That is exactly what I do as well. Don't forget your "business" loan costs you can amortize over the period of the loan include appraisals, environmental reports, attorney fees, misc. charges by the lender. This is not limited to points or origination fees due to the connection to business use property.

...mortgage insurance or PMI. This also represents a loan cost which is basis...

Not to be picky, but according to Pub 551 (I know pubs aren't authoritative), loan costs -- such as points, "mortgage insurance premiums, loan assumption fees, cost of a credit report, and fees for an appraisal required by a lender" -- are not adjustments to basis. It also says fees for refinancing a mortgage is not included in basis. Of course, prepaid interest is amortizable.

On rental, yearly PMI premiums become a rental deduction.

The following items are some settlement fees and closing costs you cannot include in the basis of the property. Fire insurance premiums.

Rent for occupancy of the property before closing.

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

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

Points (discount points, loan origination fees).

Mortgage insurance premiums.

Loan assumption fees.

Cost of a credit report.

Fees for an appraisal required by a lender.

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.

I'm not sure you could change the character of those financing expenses which were either non deductible or personal cost basis at the time incurred. Total cost basis to carryover to the converted business use is limited to current FMV. Guess you could be aggressive if cost basis is less than FMV to split this part of cost basis off to amortize over remaining period of loan. Good point!

[At the time of conversion from personal use to rental use] Whaddya do if the *land* market value is *higher* than its cost, but the *structure* market value is below its cost? Is this *one* cost basis/FMV comparison, or is it two?

Client buys home with a 200K original purchase mortgage & then refinances for $305K, $5K going for refi costs and $100K being equity/cash to borrower.

Can any of the $5K refi costs (perhaps 2/3) be considered part of the "original purchase" mortgage, since part might be attributed to refinancing the original purchase mortgage?

Thanks.