Closing Disclosure Items

By Jason Watson, CPA
Posted Sunday, May 25, 2025

The closing disclosure or settlement statement, and what old timers still call the HUD-1, has several items that have varying tax consequences. Here is a summary of the most common ones using the Consumer Finance Closing Disclosure template. In certain jurisdictions or transactions, a settlement statement is crafted by an attorney or title agency, and is not consistent. As such you must pick through it to determine what are acquisition costs, what are current years expenses, what are neither and what are complete mysteries.

A lot of this comes from IRS Publication 523 Selling Your Home, IRS Publication 530 Tax Information for Homeowners, IRS Publication 527 Residential Rental Property, and IRS FAQs from their website. Some of this is also just common accounting asset basis stuff. Here we go-

Loan Costs

Loan costs are amortized over the length of the loan term. Should you refinance, any remaining amount is immediately expensed and deducted as an operating expense (yet still limited by passive activity loss limitations if applicable). These include-

• Section A. Origination Charges which includes points, and application and underwriting fees. You might also see mortgage insurance premiums and mortgage broker fees.
• Section B. Services Borrower Did Not Shop For which includes appraisal, credit report, flood, document preparation, tax monitoring and tax status fees.
• Section C. Services Borrower Did Shop For which includes pest inspection, survey and title fees.

Be alert! At times you pay for things directly and outside of closing, such as an appraisal or application fee, and it is not recorded or not recorded correctly. Also, lender credits which appear in obscure places will reduce your overall loan costs.

Points are a fancy way of saying accelerated mortgage interest. Unlike a primary residence or second home where you can deduct points alongside mortgage interest, for rental properties, points are considered loan costs and amortized over the length of the loan. Sorry.

Section E. Taxes and Other Government Fees

These fees include recording fees, and transfer taxes (stamp taxes) and similar fees. People hear the word tax, and immediately think it can be deducted like property or real estate taxes, or sales taxes. Transfer taxes are specifically called out by the IRS as non-deductible. Rather, all these taxes and government fees are considered acquisition costs, and depreciated over 27.5 or 39.0 years, and cannot be accelerated.

Section F. Prepaids

Often a lender will ask that several months’ worth of insurance and property or real estate taxes be paid ahead of time. Under Treasury Regulations 1.263(a)-4(f) there is a rule called the 12-month rule. This allows you to deduct in full an amount where the benefit received from paying the expense spans two tax years.

Here is the exact wording-

(f) 12-month rule-

(1) In general. Except as otherwise provided in this paragraph (f), a taxpayer is not required to capitalize under this section amounts paid to create (or to facilitate the creation of) any right or benefit for the taxpayer that does not extend beyond the earlier of-

(i) 12 months after the first date on which the taxpayer realizes the right or benefit; or

(ii) The end of the taxable year following the taxable year in which the payment is made.

There is a bit of a head-scratcher with prepaid property or real estate taxes on a rental property purchase since the general position of the IRS is that the tax must be assessed and paid for it to be deducted. The 12-month rule above does not mention the words assessment or obligation. The lender requiring you to prepay your property taxes in itself does not mean the taxes were assessed. However, these are mostly timing issues with the county and most taxpayers safely deduct prepaid property or real estate taxes.

The other head-scratcher is a prepaid expense that is paid in one year, but the rental property does not go into service (ready and available for occupancy, and held out for rental use through advertising and related efforts) until the following year. These situations require more discussion.

Section G. Initial Escrow Payment at Closing

These are amounts that initially fund your escrow account with the lender. They cannot be deducted, and they are not added to the acquisition costs. They look super attractive since they have labels such as insurance or property taxes or interest which are generally tax deductible.

Section H. Other

This is where the fun begins. HOA processing fees, inspections, surveys, home warranty fee, real estate commissions, attorney fees, notary fee (not associated with the loan) and title insurance including ALTA endorsements are generally considered to be acquisition costs and depreciated accordingly.

There are some odd ducks out there such as HOA capital contribution- this is similar to initial escrow funding and generally it not deductible nor capitalized as an acquisition cost.

Acquisition Costs

Don’t forget about your acquisition costs that were paid outside of closing such as travel, lodging, legal and professional fees, meals and other related searching and acquisition costs. See our rental property acquisition costs on page 70 for more information.

Seller Credits and Debts

At times the seller will provide a general credit. One of the most common sources is a problem found on inspection. For example, there is damage to the deck where a bunch of boards are rotted, creating a safety hazard. The lender is agnostic, but you need to repair the deck before you can put the rental property into service.

One option is to have the seller make the repairs- but this takes time, and you might not have the project oversight you desire. The other option is to ask for a seller credit, and you make the repairs (or improvements) directly after closing. Many buyers opt for the second option because they can control the entire process and not take unnecessary delays in closing.

A seller credit is a general reduction in the basis of the property, and typically reduces the amount allocated to the building.

According to IRS Publication 530 Tax Information for Homeowners, “any amount the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, cost for improvements or repairs, and sales commissions” will be added as acquisition costs.

Property or Real Estate Taxes

Given the purchase timing within the calendar year as compared to when the county collects property or real estate taxes, the seller might be required to credit you the amount of taxes that they were responsible for but have not paid. If you pay the taxes later but in the same tax year, you will reduce the expense by the amount of the credit provided by the seller.

Should the credit exceed the amount of taxes paid, you essentially end up with a negative expense which in a roundabout way would be considered income. Rather, if this situation arises, the excess would be a reduction in your rental property basis and usually applied against (reduce) acquisition costs.

Also, keep in mind that several states collect property or real estate taxes in arrears. This means that taxes levied for 2024 are due and collected in 2025. This can throw off the first year and compound the seller credit problem just described.

Converting a Residence into a Rental Property

Since there are slight differences between buying a residence and buying a rental property in terms of tax deductions (for example, mortgage points) these situations get tricky when recording the rental property and associated assets on a tax return. Each conversion is unique, and needs to be carefully reviewed to ensure the basis of the rental property captures everything but also do not capture items that were otherwise deducted or deductible.

See converting primary residence to a rental section for more information.

Carrying Costs

You might choose to capitalize certain expenses that are otherwise deductible. You might do this since you are unable to take advantage of the tax deduction today, for a variety of reasons, but you will be able to in the future.

Here is a blurb from IRS Publication 527 Residential Rental Property–

Deducting vs. capitalizing costs.
Don’t add to your basis costs you can deduct as current expenses. However, there are certain costs you can choose either to deduct or to capitalize. If you capitalize these costs, include them in your basis. If you deduct them, don’t include them in your basis.

The costs you may choose to deduct or capitalize include carrying charges, such as interest and taxes, that you must pay to own property.

For more information about deducting or capitalizing costs and how to make the election, see Carrying Charges in sections 263A and 266.

We don’t want to go too far down this road, but you should be aware that might be beneficial in certain scenarios. IRC Section 263A is mandatory and generally applies to construction whereas IRC Section 266 is elective.

See capitalizing construction mortgage interest for a deeper look into carrying costs.

Summary of Closing Disclosure Items

The bottom line to all this madness is summed up in four bullets-

• The amount is a loan cost and wouldn’t exist without a lending environment, and therefore is amortized as a loan cost.
• The amount is an acquisition cost and wouldn’t exist without the transaction itself, and therefore is depreciated.
• The amount is an expense, and generally deducted as such given the constraints previously discussed.
• The amount is an escrow or pre-funding payment.

When in doubt, call the amount an acquisition cost unless it is clearly an escrow or pre-funding payment.