If you purchase a rental property, you may have to pay a number of closing costs to complete the sale. Other than the points you may pay on a mortgage, closing costs aren't deductible on a rental property. You do, however, get a different tax benefit for these costs.
Increased Depreciation Deductions
Instead of being deductible, closing costs are added to your basis in the rental property. Your basis in property is generally equal to its sale price, the cost of improvements you make and closing costs. Such costs may include abstract, legal and recording fees, transfer taxes, title taxes and back property taxes of the previous owner. It is this basis amount for which your annual depreciation deductions are derived. The higher your basis in the rental property is, the larger your depreciation deductions are.
Sale of Rental Property
In the event you later sell the rental property, the increase to your basis represented by the prior closing costs can reduce the amount of gain you'll have to report to the Internal Revenue Service. For example, suppose you purchase a rental property for $100,000 and incur $10,000 in closing costs. If you sell it one month later for $200,000, your gain is $90,000 – the selling price minus your $110,000 basis. Without those closing costs, your potentially taxable gain would be $100,000.
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.