Deduction or depreciation?

[REALWORLD]

I bought a rental house in Jan. 2005 for $55,000.00. I took a mortgage of $44,000.00. I paid 20% down ($11,000.00) plus these other settlement charges:
Loan origination fee 2%   $880.00
Appraisal fee                      175.00
Credit report                        37.79
Doc prep fee                       100.00
Underwriting review           200.00
Flood certification Fee           10.50
Flood fee                                 5.00
Recording fee                      160.50
Lawyer closing fee, abstract or title search  $250.00
The land is valued on the tax bill as $16,810.00 and the house at $38,190.00. Can I deduct or depreciate these extra $1825.12 charges? I've read IRS publications and am confused.  Thanks Sincerely

[kdhastedt]

You can take the 2% loan originination fee spread out over the duration of the loan (30 years = $29.33) on line 12 of 1040, Schedule E.

You may also take depreciation of the $38,190 over the course of 27.5 years but you have to figure the first year on basically a per diem basis.

Keith

[REALWORLD]

Thanks Keith:  My loan term is 15 years so I will figure accordingly. Does that mean the additional $945.12 can't be deducted? Does line 23 (section 263A costs) of Form 4562 apply to me for residential property? Does a water heater qualify as an appliance and get to be depreciated as 5-year property and month placed in service (convention) does not matter?
Does a bathroom remodel get depreciated over 27.5 years?
Am I correct to assume that the S/L Method is easier to figure and for small (my) capital improvements it does not make much difference what method I use because I will eventually recover my costs and have to recapture my costs? Thanks if you can answer my questions.
Sincerely

[aak5454]

My tax professional (30 years experience) routinely just takes remodel expenses against Sch E income in the year they occurred (up to couple of thosand bucks).  If you strip the house down to the studs, that a different story.

[Dave T]

You can deduct closing costs for mortgage interest and deductible real estate taxes.  Additionally, PMI premium is also expensed on Schedule E, line 9 (write in PMI on the dotted line).   All other settlement fees and closing costs for buying the property are treated as additions to your basis in the property.  

Fees related to obtaining a loan are capital expenses and should be amortized over the life of the loan.  These expenses can include loan origination fees, abstract fees, and recording fees.  You amortize them over the life of the mortgage on Schedule E, line 18.

For additional information, see IRS Pub 527, Residential Rental Property, and IRS Pub 535, Business Expenses.

Appliances used in your rental property (stove, refrigerator, washer, and dryer) are personal property and not considered as a structural component of the building.  Appliances, as well as carpeting and furniture, have a five year recovery period.

The water heater is a structural component of the building as are the furnace, water pipes, venting, wiring, etc.  Structural components, when replaced, are depreciated on the same schedule as the property, or 27.5 years for residential rental property.

Conventions establish when the recovery period begins and ends.  The convention you use determines the number of months for which you can claim depreciation in the year you place property in service and in the year you dispose of the property.  The mid-month convention is used for all residential rental property.  

[REALWORLD]

Thanks Dave T:
 You are helping to clear up my thoughts about deductions and depreciation but I do not understand your answer about  -"Fees related to obtaining a loan are capital expenses and should be amortized over the life of the loan.  These expenses can include loan origination fees, abstract fees, and recording fees.  You amortize them over the life of the mortgage on Schedule E, line 18." - I bought a rental house with a basis of $38190 and capital expenses of $1819. Why do you say they ($1819) should be entered on line 18 of Scedule E? And if I do should I enter $66 ($1819 divided by 27.5)? I don't see why I would not just add it ($1819) to the cost basis ($38190) for a total of $40009 and enter it on Form 4562 line 19h column g? Please advise, I have read IRS Publications 551 + 553 plus others.
Sincerely,
REALWORLD

[Dave T]

What is the life of your loan?  Is it a 15 year loan, or perhaps a 30 year loan?  You amortize your capital expense over the life of the loan, not the recovery period for the property.

Capital expenses include loan origination fee, appraisal fee, credit report fee, lenders title insurance, mortgage recording fees, documentary fees, and other costs that your lender may charge to obtain a loan.

Add up all these costs, and enter this total amount on Form 4562, line 42(c).  The code section is 163.  Under description of costs,line 42(a), enter "Financing Fees", ender the date of your loan at 42(b), and the amortization period in years at 42(e).  Divide the amount at line 42(c) by the number of years in your amortization period (line 42(e)).  Next prorate this amount over the remainder of the year.  If you financed or refinanced in April, then enter 75% of the annual amortization amount at line 42(f).  

Carry the amount on Form 4562, line 42(f) to Schedule E line 18.  Enter "Amortization" on the blank line.

I agree that there is not a lot of difference between a depreciation recovery period of 27.5 years and an amortization period of 30 years.  The IRS does not seem to be too particular about amortizing loan fees when you originally purchase the property either, so you could just include these costs in your basis.  However, if your loan term is shorter than the depreciation recovery period, amortizing your loan fees is to your advantage.

If you refinance the property, then you must amortize the loan fees.  You cannot "depreciate" them.

[REALWORLD]

Thanks Dave T for your tremendous help! : My loan term is 15 years and with your help have figured my depreciation to be $38475 divided by 27.5 years and my capital expenses to be $1408.29 to be entered on line 42 of Form 4562. How do I figure amortization for the year when I bought + placed in service 1/31/2005? Is it for the whole year (12 months) or 11 months and 1 day? How does a layman know what code section to enter for line d? You said code section 163 and when I tried to look that up it stated it was for "This document contains final regulations relating to an election that may be made by noncorporate taxpayers to treat qualified dividend income as investment income for purposes of calculating the deduction for investment interest."
Your help again will be greatly appreciated.
Sincerely

[Dave T]

How do I figure amortization for the year when I bought + placed in service 1/31/2005? Is it for the whole year (12 months) or 11 months and 1 day?

The date the loan amortization starts determines the amount of annual amortization.  In your example, lets assume that you purchased on 1/31/2005, and financed with a conventional 15 year fixed rate loan.  Your amortization schedule starts on 2/1/2005, with your first monthly mortgage payment due on 3/1/2005.  So, in this example, you only have 11 months of your amortization schedule in this tax year, so you would divide your financing fees by 180 (months) and multiply by 11 (months) to get the amount to include on Form 4562.  

How does a layman know what code section to enter for line d?

I did not know either until I ran TurboTax and let the tax preparation software fill in the blanks for me.  The code section my software entered in the blank on the form was "163".

[REALWORLD]

Thanks again Dave T:
I've been filling out my tax forms with 3 different tax preparation software names (Taxact, Taxcut, and Turbotax). In none of the programs does it let me list the amortization as you said. In Turbotax it has a place for amortization intangibles and when I enter the information it comes out on part III of form 4262 and ends up as a depreciation item and not an amortization on part VI and then carried as a financing fee to Sch E line 18.
If I depreciate amortization I will have to recapture it when I sell.
I was wondering if and how to enter it in Turbotax to correct?
If I just left amortization costs off of my return could I deduct them from my selling cost?
Sincerely

[yrush2000]

this is why you need your taxes done by a professional that deals in real estate and is an investor themselves since they will have a better understanding and know what extra's you can have.  Once you have rental property, dump turbotax and pay the extra 75-100bucks and have a pro do it. Chances  are they will get you enough back to justify it.

[aak5454]

that's my experience too as I have quite a few properties as TaxCut made a mess out of it. and did some "stange things" as my tax preprarer siad the following year.

doing your tax with THREE (!) different programs==self-inflicted pain