Are Escrow Fees Tax Deductible for Rental Property?

Posted Dec 6, 2021

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Owning rental property brings to the owner various tax advantages, some of which are deductions like payments for mortgage interest, operating costs, property taxes, and repairs.

Escrow funds or an escrow account is money held by a neutral third party for the benefit of the parties to a financial agreement. Typically, an escrow account is used during the purchase of a home and may also be used by a lender to collect and hold funds for certain expenses that a borrower needs to pay during the loan’s term. These accounts use the same name but serve different functions.

The payments referred to previously, like mortgage interest and property taxes, could be considered escrow payments during the purchase transaction and if the lender collects the funds into an ongoing escrow account. They are not fees in the sense that they are not payments for service, but instead, they are payments of required amounts due. On the other hand, paying fees to the escrow company for service holding capital during the escrow period may be a deductible closing cost for a landlord investor.


What Is the Escrow Agent Responsible For?

An escrow agent is a person or company with a fiduciary responsibility to oversee a property transfer from one person or party to another. The agent is the custodian of the funds entrusted to them and may release the funds only when the contractual conditions have been met, preferably with the agreement of both parties. Fees paid for the agent's service are not typically considered deductible.


What Happens During Escrow for an Investment Purchase?

The escrow process for a home purchase includes charges that typically add up to between two and five percent of the home's price. This cost may be higher in states that require the participation of an attorney in the sale process. Legal fees are not tax deductions, like other service payments. Escrow costs include:

  •       Real estate commission paid to both seller’s and buyer’s agents
  •       Loan fees to the buyer’s lender
  •       Taxes (any past due plus a set pre-paid amount of upcoming taxes) to the appropriate county
  •       Transfer fees
  •       Documentation costs and recording fees also to the county
  •       Insurance and other charges to third parties

Of these, the taxes and potentially the mortgage fees may be deductible. Also, insurance is an operating cost for the investor/owner and thus tax deductible. However, remember that the cost of the residence itself, and any improvements you make to it, are not deductible. Instead, you recoup those costs through depreciation, using IRS Form 4562. The form includes instructions for determining the appropriate depreciation schedule and allowable deduction, including carryovers.


This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

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