Determining the Cost Basis of Your Residential Rental Property

In our blog “Income and Expense for Residential Rental Endeavors,” we discuss capitalizing our rental property. Sounds easy enough, right?

In reality, a few things must be considered before determining the dollar amount you include on your balance sheet. Let’s review.

Purchased Property: The Process

You made an offer to purchase of a certain dollar amount. The offer was accepted, and the sale commenced. At closing, a slew of numbers were flying around on the settlement statement, including many additional costs beyond the dollar amount listed on your purchase offer. Some of these costs you paid at closing need to be capitalized with your purchase. Let’s jump into the specifics!

First, you need to capture the following costs in your property basis:

• Agreed upon purchase price of the property
• Broker or realtor commissions
• State stamp taxes or other transfer taxes
• Charges for installing utility services
• Legal fees (related to the property and title but not the loan)
• Recording fees or tax service fees
• Surveys
• Title fees
• Title insurance
• Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions

Next, you need to identify closing costs you can’t include in your property basis that you instead will expense in your ordinary business operations. 

• Casualty insurance premiums
• Rent or other charges relating to occupancy of the property before closing
• Prepayment of real estate taxes or insurance
• Charges for utilities or other services related to occupancy of the property before closing

Last, you need to identify charges connected with getting or refinancing a loan. These costs are not a part of the property basis and should be shown as part of the loan liability, including:

• Points (discount points, loan origination fees)
• Mortgage insurance premiums
• Loan assumption fees
• Cost of a credit report
• Appraisal required by the lender

Constructed Property: Items to Be Capitalized

If you have a general contractor building a house for you or you coordinate the building of your property, the following items should be capitalized in your property basis:

• All required building fees and permits
• Labor and materials
• Architect’s fees
• General contractor’s commission
• Payments to contractors
• Payments for rental equipment
• Inspection fees
• Landscaping
• Wells
• Septic tanks
• Interest on construction loans

All the costs you pay during the building process will be capitalized, except the cost of your personal labor or the labor of anyone for whom you did not pay for his or her services. 

Other Situations

If any of the situations below apply to you, consult with a CPA to determine the proper amount to capitalize. 

Property was received:

• In return for services you performed
• In an exchange for other property
• As a gift
• From your spouse, or from your former spouse as the result of a divorce
• As an inheritance

Now you understand the total amount that should be capitalized on your balance sheet.

Next up is deciding “How Much of My Cost Is for Land vs. Residence?” Read on to learn more.