Are Settlement Charges Included in Basis for Property Taxes?
Understand how settlement charges impact your property's tax basis and which costs can be included or excluded for accurate tax calculations.
Buying property comes with various costs, some of which affect your tax obligations. One key factor is how settlement charges impact the property’s basis, which determines capital gains taxes when you sell. Understanding what counts toward this basis ensures accurate tax reporting and can reduce taxable gains.
Not all settlement charges are treated the same for tax purposes. Some increase your property’s basis, while others do not. Knowing which expenses qualify can prevent mistakes and clarify potential deductions or adjustments.
Settlement Charges and Basis
The basis of a property includes the purchase price and certain transaction expenses. The IRS allows some settlement charges to be added, increasing the basis and potentially reducing taxable profit when the property is sold.
Settlement charges included in the basis generally relate to acquiring or improving the property rather than financing it. The IRS provides guidance in Publication 551, specifying what qualifies. Legal fees for preparing the deed, costs for perfecting the title, and certain government-imposed charges may be added. These expenses become part of the property’s adjusted basis, which is used to calculate depreciation for rental properties and capital gains when selling.
Types of Settlement Charges Typically Included
Some settlement charges are added to a property’s basis because they are directly related to acquiring ownership. These costs generally involve legal, administrative, and government-imposed fees necessary to transfer the property.
Title and Transfer Fees
Title-related costs establish legal ownership and may include title search fees, title insurance premiums (for the owner’s policy), and attorney fees for title documents. A title search ensures there are no outstanding claims or liens, while title insurance protects against future ownership disputes.
Transfer fees, such as real estate transfer taxes imposed by state or local governments, are also included. These taxes are typically calculated as a percentage of the purchase price, varying by location. In New York City, for example, the Real Property Transfer Tax (RPTT) ranges from 1% to 2.625%, depending on the property’s value. Since these fees are required to complete the transaction, they are considered part of the acquisition cost and increase the property’s basis.
Surveys
A property survey determines boundaries and identifies encroachments or easements. Lenders often require a survey before approving a mortgage, but buyers may also obtain one to avoid disputes.
Survey costs are included in the basis because they help establish clear ownership. The price varies based on property size and location, generally ranging from $300 to $1,000. If a survey reveals boundary issues requiring legal resolution, any additional legal fees incurred to correct the problem may also be added. However, if a survey is conducted solely for the lender’s benefit and not required for the transfer of ownership, it may not qualify.
Recording Costs
Recording fees are charged by local government offices to document the property transfer. These fees ensure that the new ownership is legally recognized and that the deed is entered into public records. The cost varies by jurisdiction, typically ranging from $10 to $100 per page.
Since recording the deed is necessary to establish legal ownership, these costs are included in the basis. Additional recording fees may apply for documents such as easements or restrictive covenants. If these documents are required as part of the purchase, their recording costs can also be added. However, fees for recording a mortgage or other loan-related documents are not included, as they pertain to financing rather than ownership.
Charges Generally Excluded from Basis
While some settlement charges increase a property’s basis, others are considered financing costs or personal expenses and cannot be included. The IRS explicitly excludes certain costs in Publication 551, meaning they cannot be used to reduce taxable gains when selling the property. Some of these expenses may be deductible in the year they are incurred or amortized over the life of the loan.
Loan Origination Fees
Loan origination fees, also known as points, are charges paid to a lender for processing a mortgage. These fees are usually expressed as a percentage of the loan amount, with one point equaling 1% of the total loan. For example, on a $300,000 mortgage, a lender charging two points would require a $6,000 payment at closing.
Since these fees are tied to obtaining financing rather than acquiring the property itself, they cannot be added to the basis. However, in some cases, they may be deductible as mortgage interest. The IRS allows borrowers to deduct points in the year they are paid if the loan is used to purchase or improve a primary residence and meets specific criteria outlined in Publication 936. If the loan is for a rental or investment property, the points must be amortized over the life of the loan rather than deducted immediately.
Appraisal Fees
An appraisal determines a property’s fair market value, which lenders require to ensure the home is worth the loan amount. Buyers may also order an independent appraisal to confirm they are paying a reasonable price. The cost typically ranges from $300 to $600, depending on the property’s size and location.
Because an appraisal is primarily for the lender’s benefit and does not directly contribute to acquiring ownership, it is not included in the basis. The IRS considers it a financing expense rather than a capital cost. Unlike loan origination fees, appraisal costs are not deductible in most cases. However, if the property is used for rental purposes, the fee may be deductible as an operating expense under Section 162 of the Internal Revenue Code, which allows deductions for ordinary and necessary business expenses.
Mortgage Insurance
Mortgage insurance protects lenders in case a borrower defaults on the loan. It is typically required for conventional loans with a down payment of less than 20% and for government-backed loans such as FHA and VA mortgages. The cost varies based on loan amount, credit score, and loan type, with annual premiums often ranging from 0.5% to 2% of the loan balance.
Since mortgage insurance is a financing-related expense, it does not increase the property’s basis. However, it may be deductible under Section 163(h)(3)(E) of the Internal Revenue Code, which allows taxpayers to deduct mortgage insurance premiums as qualified residence interest, subject to income limitations. As of 2024, this deduction is available for taxpayers with an adjusted gross income (AGI) below $100,000 ($50,000 for married individuals filing separately), with a phase-out beginning above these thresholds. If the deduction is not extended by Congress, it may no longer be available in future tax years.