Refinancing a rental property can be a smart financial move, and some of these costs are often tax-deductible, saving you money when tax season rolls around.
The key thing to know is that most refinance fees for a rental property are amortized over the life of the loan, spreading out the deduction across several (or many) years.
In this article, you’ll learn about the specific refinance closing costs that qualify for tax deductions, how to properly document these expenses, and practical tips to maximize your tax benefits.
Here’s a sample list of the specific refinance closing costs you can deduct from your taxes and a brief explanation of each expense. Note that some costs, such as title search and recording fees, are added to the property cost basis and depreciated over 27.5 years for a residential rental property or 39 years for a commercial property.
When preparing to refinance, have documents like your income statements, rental income records, and property information ready. That facilitates the application process and helps ensure you provide all necessary details accurately.
Typically, lenders look for a good credit score, often well above 640, but they may also consider the financial performance of your rental property. Keeping your rentals’ financials in order could positively influence the lender’s decision and help you secure better loan terms.
Unlike an owner-occupied residence, the appraisal for a rental property often includes an analysis of the rental income potential and comparable rental properties in the area. This comprehensive evaluation helps ensure the appraisal accurately reflects the property’s market value and income-generating capability.
A mortgage insurance premium (MIP) is sometimes required if your down payment or equity in the property is less than 20%. Generally, you can deduct mortgage insurance premiums in the year you pay them.
However, if you prepay premiums for more than one year in advance, you can only deduct the portion that applies to each specific year of coverage. This way, your deductions accurately match the period the insurance covers.
Points, sometimes known as discount points or loan origination points, are prepaid interest that you pay upfront to reduce the interest rate on your loan. You might be more inclined to pay points if you plan on holding the property long-term.
Conversely, paying points might not make business sense if you plan on selling the property soon, as you may not recoup the additional upfront cost through the potential long-term savings on interest.
Typically charged by the lender, these are costs associated with creating the loan. They may include charges for application processing, underwriting, funding the loan, administrative services, and document preparation.
Certain rental property loans, such as FHA and VA loans, might be assumable if you use part of the property as a primary residence. That allows you to take over the seller’s existing mortgage.
If you assume an existing loan as part of your refinancing agreement, you can deduct the associated fees. These fees compensate the lender for transferring the loan to you and are typically amortized over the loan’s term.
Here’s a practical step-by-step breakdown of how some loan closing costs get amortized over the life of a loan.
Suppose you’re refinancing your rental property with a new loan amount of $250,000. Closing costs typically range between 2% and 5% of the loan amount. For this example, we’ll assume your total closing costs are 3%.
First, you determine the total closing costs:
Next, you amortize these closing costs over the life of the loan, which is often 30 years (360 months), to find the annual tax deduction. You do this by dividing the total closing costs by the number of years in the loan period:
So, if you refinance your rental property with a new loan amount of $250,000 and closing costs of $7,500, you can deduct $250 annually over the 30-year term of your loan.
The IRS typically requires you to use Form 4562 to report any amortizable costs the year you refinance.
Each subsequent year, you can list the amortization amount on line 19 (under “Other”) of Schedule E (Form 1040) using the label “Amortization,” which reports income or loss from rental real estate.
Be sure you keep all receipts, statements, and the HUD-1 Settlement Statement as proof of your expenses.
Proper recordkeeping can save you time, reduce stress during tax season, and maximize your financial benefits. Here are some essential tips and practices to follow:
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With features like automated bookkeeping, seamless expense tracking, landlord banking, and real-time financial reporting, Stessa helps take the hassle out of managing your portfolio.
Whether you need to scan receipts on the go or manage transactions from your desktop, Stessa helps ensure all your records are in one place, making tax season a breeze.
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