Loan Origination Costs
There is always a lot of confusion, even
among tax pros, as to the proper ways to treat, for tax purposes, the costs to
obtain a new mortgage.
The only time loan origination costs are
fully deductible in one lump sum is when it is for the purchase of a primary
residence. With any refi on a primary residence or the refi or purchase of any
other kind of property (including rentals), the loan costs must be amortized
over the life of the loan.
There are different approaches to handling the amortization period. Most people
and IRS loving tax pros use the nominal life of the loan, such as 30 years, and
deduct one-thirtieth of the cost each year, giving a very tiny deduction each
year. When the loan is paid off early, through another refi or a sale, whatever
unamortized portion of the original costs are remaining can be deducted in full
in that year.
My approach, which I have been using for well over 20 years, and has always been
accepted by IRS, is to use the expected life of the loan. It is very rare that
anyone's mortgage lasts a full 30 years, so I use the length of time we think it
will last. Barring any special situation with the client (pending sale or new
refi), I have been using five years as my standard expected life. This allows
us to deduct one-fifth of the costs each year. If the loan actually lasts
longer than that, there will be no amortization in the sixth and subsequent
years. In the 20 + years I have been doing it this way, there may have been one
or two times when this has happened. The five year life has generally been
longer than needed.
In fact, whenever I have started working with a new client who had started
amortizing loan costs over some ridiculously long life (30 years), I immediately
switched them to the more realistic five years. Again, IRS has never once
disagreed with that move.
In subsequent years, after starting with a five year expected loan life, we can
modify the remaining expected life if situations change, such as a pending sale
Amortization of loan fees, as well as final write-off of remaining costs, are to
be shown under "Other Expenses" (Line 18) on the Schedule E for that rental.
For any loan that no longer exists, you must deduct the remaining loan costs in
that year, regardless of the size. IRS could disallow the amortization of those
costs in future years after the loan no longer exists. If there are more than
one loan to be amortized in a single year, it's a good idea to list them
separately either on Line 18 or on a backup schedule for the Amortization
Regarding the other costs associated with
obtaining a loan in addition to the points.
What I have always done is use a wide
interpretation of "loan origination cost" by combining all of the fees related
to obtaining the loan, including the points, appraisal, credit reports, title
insurance and doc prep fees. It's a loose interpretation that many other tax
pros don't follow. However, I have actually been able to convince IRS auditors
to accept my rationale, on the few occasions that they looked at this item on
returns I had prepared.
The other, more conservative approach is to capitalize the additional non-points
fees as part of the cost of the property.
Direct expensing of them is not something that you can do.
This page was updated:
Sunday, January 29, 2012