Real Estate Tax Calc
The IRS rule on capital vs. deductible expenditures at closing
The Internal Revenue Code draws a fundamental line between capital expenditures and currently deductible expenses. Under IRC §263, amounts paid to acquire, produce, or improve property generally must be capitalized—added to the cost of the asset—rather than expensed in the year paid. Closing costs are, in large part, costs incurred to acquire the property, which means they fall on the capital side of that line.
Your cost basis under IRC §1012 starts with the price you pay for the property and increases by the capitalized costs of acquisition. This matters because basis reduces your taxable gain at sale. It also matters for rental property because the depreciable basis—the building's share of total basis—is what you write off over 27.5 or 39 years of depreciation.
The IRS does carve out narrow exceptions for costs that are not truly acquisition costs: genuine interest (which is always deductible under §163 if the other tests are met), deductible taxes, and insurance premiums deductible as a business or investment expense. Outside those carve-outs, if an amount appears on your closing disclosure because you are buying property, there is a strong presumption that it must be capitalized.
Items deductible in year one
Despite the broad capitalization rule, the following amounts are typically deductible in the year of closing:
Prepaid per-diem mortgage interest. The interest that accrues from the closing date to the end of the closing month is genuine interest, deductible under §163. On a primary residence it goes on Schedule A as qualified residence interest. On a rental it goes on Schedule E.
Your prorated property taxes. Property taxes covering your ownership period are deductible as taxes under IRC §164. On a primary or second home they go on Schedule A, subject to the $10,000 SALT cap. On a rental they go on Schedule E without the cap limitation. Only your ownership-period share qualifies; taxes allocable to the seller's pre-closing period are the seller's deduction.
Prepaid hazard insurance on a rental. For a rental property, hazard insurance is a deductible operating expense on Schedule E, but only as the coverage period is consumed. If you prepay 12 months of coverage at closing and the policy starts at closing, you deduct the months that fall in the current tax year. For a primary residence, homeowner's insurance is a personal expense and generally is not deductible.
Points on a primary-residence purchase (if qualifying). Under the rules of IRS Publication 936 and IRC §461(g)(2), mortgage points that meet the specified tests may be deducted in full in the year paid on a primary-home purchase. Key requirements include: the loan must be secured by your main home, points must reflect an established area practice, and the amount must not exceed customary local rates. This exception does not extend to rental property purchases or to refinances of any kind.
Items added to basis
The following closing costs are capitalized into your property's cost basis and are not deductible in the year of purchase:
Title insurance (owner's and lender's policies). Added to basis for all buyers, no exceptions.
Attorney fees, closing-agent fees, and escrow fees. All acquisition-related legal and administrative costs are capitalized.
Transfer taxes, deed taxes, and documentary stamp taxes. Added to basis for buyers, even if the buyer voluntarily pays a portion the seller traditionally covers.
Recording fees. Fees for recording the deed and mortgage are part of the acquisition cost and are capitalized.
Appraisal fee (purchase appraisal). Added to basis on acquisition. An appraisal obtained post-acquisition for insurance purposes or to support a tax position (not acquisition) may be deductible as an operating or investment expense, but the purchase appraisal is a basis-eligible cost.
Home inspection fee. If you acquire the property, the inspection fee is added to basis. If the deal falls through and you never acquire the property, you may have an investment-loss deduction—consult a tax advisor.
Survey fees. Added to basis as an acquisition cost.
Items amortized over the loan term
Loan origination fees and points on a rental property are neither immediately deductible nor added to property basis. Instead, they are treated as financing costs and amortized over the stated term of the loan. Each year, you deduct a ratable portion on Schedule E, reported through Form 4562, Part VI.
Common items in this amortized category on a rental include: loan origination points, loan processing fees, underwriting fees, and document-preparation fees imposed by the lender as conditions of the loan. Fees charged by the closing agent or attorney for services unrelated to the loan itself are capitalized into property basis rather than amortized.
If you sell the property or pay off the loan before the amortization period ends, the entire remaining unamortized balance is deductible in the year of payoff. Many rental investors leave this deduction on the table when they refinance or sell—check your records carefully.
Rental property: broader recovery options
While the capitalization rules are the same for rental and primary-home buyers, rental-property investors have two recovery mechanisms that primary-home buyers do not: annual depreciation and amortization of financing costs.
On a residential rental, the building's depreciable basis—which includes closing costs allocated to the building—is recovered over 27.5 years under MACRS. On a commercial rental, the recovery period is 39 years. Land is never depreciable, so you must allocate the purchase price and all closing costs between land and improvements at acquisition. The county assessor's land-to-improvement ratio is the most commonly used allocation method; a purchase appraisal is another acceptable method.
Rental investors who acquire property with a cost-segregation study can reclassify portions of the building cost into 5-year, 7-year, or 15-year property, accelerating depreciation dramatically. Closing costs allocated to those reclassified components also benefit from the shorter recovery period. Bonus depreciation rules (which phase down under current law after 2022) can allow immediate expensing of qualifying components.
Worked example: $425,000 duplex purchase with $11,000 in closing costs
You buy a duplex for $425,000. Your county assessor's ratio is 75% improvement / 25% land. Closing costs total $11,000. Here is how each item is categorized:
Loan origination points — $2,550 (0.6% of $425,000). Amortized over 30 years on Form 4562. Annual deduction: approximately $85/year on Schedule E.
Owner's title insurance — $1,400. Added to basis. 75% × $1,400 = $1,050 to depreciable basis; $350 to land basis.
Lender's title insurance — $600. Added to basis. $450 depreciable; $150 land.
Attorney/closing-agent fees — $1,200. Added to basis. $900 depreciable; $300 land.
Transfer and recording taxes — $1,100. Added to basis. $825 depreciable; $275 land.
Appraisal and inspection — $700. Added to basis. $525 depreciable; $175 land.
Property-tax proration — $2,100. Deductible on Schedule E in the year paid. Your ownership period: roughly 4 months, so $2,100 is the seller-credited amount you pay at closing—deductible in full in year one.
Prepaid per-diem mortgage interest — $800. Deductible on Schedule E in year one.
Prepaid hazard insurance — $550. Deductible on Schedule E as the coverage period is consumed—approximately $275 in year one if you close mid-year.
Summary: Immediately deductible in year one: $2,100 + $800 + $275 = approximately $3,175. Amortized over 30 years: $2,550 (about $85/year). Added to depreciable building basis: $1,050 + $450 + $900 + $825 + $525 = $3,750 (recovered over 27.5 years, about $136/year). Added to non-depreciable land basis: $1,250. Your adjusted depreciable basis rises from the purchase-price building allocation of $318,750 to $322,500.
Refinance closing costs—different rules
Refinancing a property is not an acquisition—you are restructuring your financing, not buying property. As a result, refinance closing costs do not enter property basis and are not recovered through depreciation. Instead, they are amortized over the term of the new loan on Form 4562.
Common refinance costs that are amortized include appraisal fees, title search and insurance (on the new loan), lender origination fees, attorney fees for the refinance, and points paid to reduce the rate. On a cash-out refinance, all of these are amortized over the new loan term regardless of how the cash-out proceeds are used.
If you pay off the new loan early—through another refinance or a sale—the remaining unamortized refinance costs are deducted in full in the payoff year. Track these amounts carefully, because they can represent thousands of dollars of deferred deductions.
How to document your basis at closing
Proper basis documentation is critical because the IRS has no independent record of your acquisition costs. When you sell, the burden is on you to substantiate every basis claim. Here is what to retain permanently:
The closing disclosure (CD) or HUD-1. This is the foundational document. Store it permanently with your property records—not just for the audit window, but indefinitely, because basis carries forward through 1031 exchanges.
Land-vs.-building allocation worksheet. Document the county assessor ratio or appraisal you used, applied to both the purchase price and each basis-eligible closing cost. Keep this in writing.
Depreciation schedule. If you own a rental, your Form 4562 depreciation schedule should show the depreciable basis including closing costs allocated to the building. Keep a running record of each year's depreciation taken so your adjusted basis is always current.
Amortization schedule for loan fees. Keep a table of origination fees and points—original amount, annual amortization, and remaining balance—so you can claim the full remaining deduction if you pay off the loan early.
Frequently asked questions
Are attorney fees at closing deductible?
Not for a buyer acquiring a property—attorney fees are an acquisition cost added to basis, not a current deduction. For a seller, attorney fees are a selling expense that reduces the amount realized on the sale, which in turn reduces the taxable gain reported on Form 4797 or Schedule D.
Are property taxes paid at closing deductible?
Yes, the portion of property taxes that covers your ownership period is deductible as a property-tax payment. On a primary residence it goes on Schedule A (subject to the $10,000 SALT cap). On a rental property it goes on Schedule E. Taxes covering the seller's period belong to the seller.
Are closing costs deductible on a rental property purchase?
Most are not immediately deductible. Title insurance, attorney fees, transfer taxes, and appraisal fees are added to depreciable basis and recovered over 27.5 years (residential) or 39 years (commercial). Loan origination points are amortized over the loan term on Form 4562—not deducted upfront. Only prepaid interest, prorated property taxes, and prepaid insurance (as consumed) are immediately deductible.
Can I deduct my home inspection fee?
If the inspection is on a property you acquire, the fee is part of the acquisition cost and is added to basis—not currently deducted. If you paid for an inspection on a deal that fell through before acquisition, that cost may be deductible as an investment expense; consult a tax advisor about your specific circumstances.
What if I forget to add closing costs to my basis?
You can generally file an amended return to correct basis additions, or you can reconcile the error when you prepare Form 4797 or Schedule D at the time of sale. Understating basis overstates your taxable gain, so correcting the error is worth the effort. A tax professional can help determine whether an amended return is necessary or whether a basis correction at sale is sufficient.
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.