Rental properties are a great investment opportunity, but there are upfront costs. Purchasing your rental property involves getting a mortgage and paying closing costs.
Closing costs are typically 3-6% of the home purchase price, costing you thousands more in additional expenses. Owners of rental properties can get back some of their closing cost expenses through tax deductions.
All properties incur closing costs as a result of their sale. Closing costs are the additional expenses beyond the cost of the property, and include all the fees and taxes you pay.
For rental properties, closing costs include:
There are only three types of rental property closing cost deductions the IRS allows taxpayers to take. You can deduct the interest and points on your mortgage and the real estate taxes belonging to your rental property.
● Mortgage interest
Rental property owners can deduct the interest they pay on their rental property’s mortgage from their taxes. You are not allowed to deduct the principal amount of your loan.
Investors should use Form 1098 to record the amount they paid in mortgage interest for each tax year. Your lender may also send you a yearly form with your mortgage interest information.
● Mortgage points
Mortgage points, also known as discount points, are paid to the mortgage lender in exchange for lower interest rates on your loan. Each mortgage point represents 1% of your loan’s value and can help cover expenses like credit checks, document preparation, borrower certification, and other mortgage-related fees.
Some mortgage points can be deducted from your taxes immediately, while others can only be deducted slowly over the length of your mortgage. Your lender can help you determine which points are deductible each year.
● Property taxes
Your property taxes are prorated from the date you close on your property through the end of the tax year. You will only pay taxes for the months you own the property the first year. You can deduct the full amount of the property taxes you paid from your taxes each year.
If the property you own is your primary residence, you can take additional closing cost deductions on top of property taxes, mortgage points, and mortgage interest.
You’re allowed to deduct the cost of your mortgage origination fees and your mortgage insurance premiums if the property is your primary residence. Rental property owners aren’t allowed to take these tax deductions.