Treatment of refinance for rental properties

BTW, I have not re-read the foregoing posts, but to the extent you are netting charges against credits, I think that's wrong. Each gets its own treatment. For instance, maybe the amortization of the loan costs over the term of the loan is straight-line, while the amortization of the credit might be on a basis of the loan balance, i.e., an interest reduction.

Nilodop,

I believe that charges and credits can be netted if they are of the same character, and no otherwise. Example of former: capital gain and loss, example of the latter: capital gain and investment expenses.

In this case, what is the purpose of the lender credit? It is to help the borrower with the "loan cost", for sure. So the lender credit can be used to reduce the "loan cost".

If there is an extra in credit over the "loan cost", can the credit used to reduce the costs associated with the basis items (government recording fees, transfer taxes, etc)?

The lender does not make an distinction, nor cares. Their goal is "zero cost" refinance. So their credit not only covers the true "loan cost", but also the cost associated with basis, as well as the prepaid escrow items (insurance, HOA fees, etc) effectively to make it zero cost and sometimes "negative" cost.

Even though "we" makes the distinction, by applying the deminimis rule, everything comes down to income and expenses, which creates an effective netting.

Strictly speaking, I believe there are three categories involved in refinance:

- Loan cost (credit report, etc), positive or negative after netting. This should be amortized over the term of the loan.

When the total credit is more than the total cost, the net is a "negative" loan cost that should be amortized by analogy to positive loan cost, but I do not think the IRS will object if we take the negative cost (positive income) all at once as it is in favor of the IRS, besides technically we cannot use a negative amount for amortization although mathematically it should be allowed.

- Addition cost basis (government recording fees, etc). This should be depreciated over 27.5 years.

- Expenses (escrow items such as insurance). Deducted when paid.

but I would simplified the treatment by applying the de minimis rule, whenever possible.

What you meant by "proceeds of the refi loan" is the same as "lender credit"? So if we "minus lender credit", the remainder can still be deducted, no? The scenario deals with the combined cost is more than the credit.

I have no idea what you mean. What I meant was that the loan costs must be paid in cash rather than paid from the proceeds of the refi loan.

And I am not reaching the conclusion that if they are paid in cash, they are deductible, because I still believe that 1.263(a)-5(d)(3) doesn't apply to this situation.

“and certain other transactions” “any issuance of debt” Yes

Agreed. There was a lengthy discussion about the $5k rule and business loan costs a while ago:

viewtopic.php?f=8&t=19647&p=170054&hilit=%245%2C000+loan+costs#p170054

- Addition cost basis (government recording fees, etc). This should be depreciated over 27.5 years.

I find this thread to be a little odd. You have a singular transaction that involves a re-financing. Everything other than the obvious (pro-rations, escrow stuff) is a cost of the re-financing.

I find this thread to be a little odd. You have a singular transaction that involves a re-financing. Everything other than the obvious (pro-rations, escrow stuff) is a cost of the re-financing.

Not so odd as those items (government recording, transfer taxes, etc) are cost basis in an initial purchase. In re-finance, they are considered incidental and lumped together with loan cost?

Not so odd as those items (government recording, transfer taxes, etc) are cost basis in an initial purchase. In re-finance, they are considered incidental and lumped together with loan cost?

Right. Not so odd. Two different transactions.

Pura, you're mixing apples and oranges. I think if you looked into the settlement statement a little further, you'd find gov recording costs are to record the mortgage, not the property deed, as there isn't a sale or transfer merely by virtue of a refi. And the transfer taxes are usually what are also called "intangible taxes" in many jurisdictions. i.e. They're assessed against the face value of a newly recorded mortgage, not on the transfer of property. Both of these are bona fide financing costs and have nothing to do with the property cost basis.

I'm curious. If the lender credit was more than the costs, did the client get a check at closing?

Probably. Cash to/from would indicate that he is due cash, even if it's not a cash-out refi.

I'm curious. If the lender credit was more than the costs, did the client get a check at closing?

The lender credit is normally not more than the "total costs" which includes escrow items such as prepaid taxes, insurance, home owner association fees, etc. These expenses are deducted when paid. So the extra credit over the "loan costs" should be used reduce these expenses (since they are paid partly by others)?

So the extra credit over the "loan costs" should be used reduce these expenses (since they are paid partly by others)?

Yes. Not very different than when the buyer receives a credit for property taxes allocable to the seller. That cash received reduces the amount of property taxes paid by the buyer and thus the deduction when they're eventually paid.

Pura, you're mixing apples and oranges. I think if you looked into the settlement statement a little further, you'd find gov recording costs are to record the mortgage, not the property deed, as there isn't a sale or transfer merely by virtue of a refi. And the transfer taxes are usually what are also called "intangible taxes" in many jurisdictions. i.e. They're assessed against the face value of a newly recorded mortgage, not on the transfer of property. Both of these are bona fide financing costs and have nothing to do with the property cost basis.

Man: I checked a few closing documents in Virginia with and without mortgages, and confirmed what you said: there are separate recording fees for the deed (property) and mortgage, and separate transfer taxes for deed (property) and mortgage as well. The tax part can be seen in this calculator: https://anytimeestimate.com/title-insur ... insurance/ .

This IRS publication https://www.irs.gov/pub/irs-pdf/p551.pdf says "transfer taxes" can be added to the cost basis, but it does not differentiate the taxes for deed or mortgage.

This IRS publication https://www.irs.gov/pub/irs-pdf/p535.pdf says:

Expenses paid to obtain a mortgage. Certain expenses you pay to obtain a mortgage cannot be deducted as interest. These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses. If the property mortgaged is business or income-producing property, you can amortize the costs over the life of the mortgage.

Although recording fees are not expenses to "obtain" a mortgage, but it clearly says they are capital expenses, so we can trust it. By analogy, the transfer taxes for mortgages are also loan costs, but can you find the authority? I search within my capacity but found none. I ask this question just to get the bottom of the truth.

PS:

This unofficial website https://www.taxaudit.com/tax-audit-blog ... d-to-basis specifically says "Mortgage-related items that can be added to the basis include recording fees, owner's title insurance, and more." It is indirect conflict with the IRS publication so I think it is wrong.

This IRS publication https://www.irs.gov/pub/irs-pdf/p551.pdf says "transfer taxes" can be added to the cost basis

That's because they're referring to transfer taxes on transfer of title. They're not referring to intangible taxes, which are sometimes (sloppily) referred to as transfer taxes on settlement statements.

I think this is probably the root of your problem. There isn't conflicting information out there. It's just the settlement statement is calling them one thing, which another thing happens to be called, and you're now conflating the tax treatment.

Intangible taxes are financing costs, plain and simple. We don't need to complicate this.

Although recording fees are not expenses to "obtain" a mortgage

Fees to record a mortgage with the county are absolutely expenses to obtain a mortgage. I don't understand how they could be interpreted as anything else in the situation described in the OP.

Try this: tell the lender you don't want to pay for recording the mortgage with the county nor the intangible taxes because you feel they're unnecessary for issuing a loan. What is their response?

but can you find the authority?

Respectfully I don't see any need. Once you accept that these are financing costs, everything else falls into place.

but can you find the authority?

Rev. Rul. 70-360, 1970-2 C.B. 103; Detroit Consolidated Theaters, Inc. v. Commissioner, 133 F.2d 200 (6th Cir. 1943); Lovejoy v. Commissioner, 18 B.T.A. 1179 (1930); Carlson v. Commissioner, 24 B.T.A. 868 (1931); Enoch v. Commissioner, 57 T.C. 781, 794-95 (1972), acq. 1974-1 C. B. 1.

but can you find the authority?

Rev. Rul. 70-360, 1970-2 C.B. 103; Detroit Consolidated Theaters, Inc. v. Commissioner, 133 F.2d 200 (6th Cir. 1943); Lovejoy v. Commissioner, 18 B.T.A. 1179 (1930); Carlson v. Commissioner, 24 B.T.A. 868 (1931); Enoch v. Commissioner, 57 T.C. 781, 794-95 (1972), acq. 1974-1 C. B. 1.

Except for the first case ("Rev. Rul. 70-360, 1970-2 C.B. 103"), I read through the rest 4 cases which are summarized below. Perhaps due to their ages, they discuss whether "loan cost" are deductible and how to deduct, and they are clear by now.

What I seek authority for is whether the recordation fee and tax on the mortgage loan are part of the "loan cost". I have this doubt because the IRS' language is "Expenses paid to obtain a mortgage" (https://www.irs.gov/pub/irs-pdf/p535.pdf).

You obtain the loan from a financial institution, and they do not charge he recordation fee and tax on the mortgage. After Bank's approval, you "obtained" the mortgage in some technical sense. I do understand that without paying the recordation fee and tax on the mortgage through the closing process, you cannot get a penny from the bank, so they are part of "obtaining" a mortgage. The publication already listed "recording fees", so I am just looking for transfer tax on the mortgage, logically it is part of the "loan cost", I just cannot find any written document.

Detroit Consolidated Theaters, Inc. v. Commissioner, 133 F.2d 200 (6th Cir. 1943)" - https://law.justia.com/cases/federal/ap ... 0/1544641/

commissions paid during the taxable year which represented the cost to petitioner of securing two long-term loans were not deductible in full for the year when paid but should be spread ratably over the period of the loans.

"https://cite.case.law/bta/18/1179/" - https://cite.case.law/bta/18/1179/

We are of opinion that the respondent correctly disallowed the deduction in 1924 of the items in question as ordinary and necessary expenses.

"Carlson v. Commissioner, 24 B.T.A. 868 (1931)" - https://cite.case.law/bta/24/868/

It is the contention of the petitioner that the full amount of $40,000 paid by him in 1926 to the Chicago Trust Company for its services in procuring a loan of $2,000,000 from the Metropolitan Life Insurance Company of New York to petitioner is deductible in that year as an ordinary and necessary business expense.

"Enoch v. Commissioner, 57 T.C. 781, 794-95 (1972), acq. 1974-1 C. B. 1." - https://www.irs.gov/pub/irs-wd/1220004.pdf

Debt issuance costs (such as underwriting costs, commissions, and other costs related
to the issuance of a debt instrument) generally are capitalized and amortized or
deducted over the term of the debt instrument to which the costs relate.

Respectfully I don't see any need. Once you accept that these are financing costs, everything else falls into place.

Man: I do accept that transfer tax on mortgage is part of the expenses to obtain a loan, and should be amortized, based on that without paying the fee, you cannot really get a penny from the bank despite their pre-approval as you argued. The need for authority is just for confirmation. In case of answering the IRS' audit, they do not care what I accept, but an authority.

While the chance for IRS audit on transfer tax treatment is small, here is a practical issue that every practitioner would face:

In most closing documents, the loan costs paid to the bank are listed in the "loan charges", and there is a section "government recording and transfer taxes". As we discussed the recording has two parts, the deed recording and mortgage recording, so is are the transfer taxes. The recording and transfer taxes on mortgage should be added to the fees paid to the bank to be amortized, and the recording and transfer taxes on deed are part of the basis of the rental property to be depreciated.

This is a lot of work, and often times the recording fees and taxes are not allocated to deed and mortgages, but are presented as total amounts, and you have to be familiar with local laws (some counties charge a tax as well, for example, Fairfax county in VA charges 1/3 of the state transfer tax on deed, but not on mortgage).

My asks here are: is that (separate treatments of recording fees and taxes on deed and mortgages) the right thing to do? Any simplifications? Can de minimis rule be applied here? If so how? Thanks!

is that (separate treatments of recording fees and taxes on deed and mortgages) the right thing to do?. Isn't that what members are telling you above?

Any simplifications? Can de minimis rule be applied here? If so how?. Not generally, but how likely is it that, considering the amounts involved and the likely very small annual differences, most agents won't care. (I have no citation for that.)

However, if the fees/taxes meet the requirements of 1.263(a)-1(f), they can follow the de minimis treatment.

If your firm is regularly putting rentals into service you should be familiar with what to look for, and also bare minimum what your state and local jurisdictions assess as far as transfer taxes and intangible taxes. I don't feel it's a lot of work, but YMMV.

If your firm is regularly putting rentals into service you should be familiar with what to look for, and also bare minimum what your state and local jurisdictions assess as far as transfer taxes and intangible taxes. I don't feel it's a lot of work, but YMMV.

Man: thanks for the response. I agree it is not a lot of work, it is some work, in the peak of season, time is limited, every minute counts, so it seems like a lot of work.

Things are pretty much clear now, thanks all for contributing! The only two things that I need clarification are:

In the initial purchase, the loan cost is buried in the closing doc, and the de minimis rule requires the total to be less $5,000. Are the loan cost and purchase cost are considered as two different transactions? As long as loan cost is less than $5,000, we can expense it (deduction in full) instead of amortizing it over the term of the loan?

In the initial purchase, the recording fees for deed, transfer tax for deed and the purchase are separate transactions for the evaluation of $5,000 purpose required by the de minimis rule? Unlike the previous point, this does not create any simplification as the cost basis needs to be depreciated anyway, and adding additional cost basis does not create more work, so this is just a concept clarification.