Rental Property Acquisition Costs

By Jason Watson, CPA
Posted Saturday, August 3, 2024

The question comes up often- what costs can I deduct in the acquisition of a rental property. There are several, but the rub is that most expenditures associated with purchasing a rental property are considered costs (versus expenses) and are depreciated or amortized accordingly. As such, you get a deduction for acquisition expenditures, but it takes time.

Travel Expenditures

Travel expenses associated with start-up and acquisition have four important distinctions-

• Start-up travel costs, before a specific rental property is identified, are generally immediately deductible under IRC Section 195. There are limitations. See our start-up costs sections for more information.

• Acquisition travel costs including meals in a new geographical location. These are generally added to the purchase price of the rental property, and depreciated accordingly. Yuck.

• Travel expenses for additional rental properties in the same geographical location are generally immediately deductible as operating expenses. Yay.

• Travel costs, after you already have a rental property but in a different geographical location, are considered a new business venture and therefore would be considered start-up costs if you have not identified the target rental property. Once identified, the travel costs change to acquisition costs.

So, travel expenditures could be start-up costs, acquisition costs or operating expenses depending on timing, geography and whether you already own a rental property.

Sidebar: Did you also notice the word change between expenses and costs? Costs and expenses are similar concepts, and they’re sometimes used interchangeably. However, a cost typically refers to the price paid to acquire an asset such as a rental property, while an expense is an ongoing expense or associated with operations. This also aligns with the term cost basis when speaking about assets.

Let’s run through some examples. The first example highlights start-up costs so you can see the difference- you travel to Miami four different times looking at various rental properties each time, and you eventually identify and close on a nice condo. Prior to identifying the target business or in this case, the rental property, these expenses might be considered start-up expenses and therefore deductible.

IRC Section 195(c)(1) reads in part-

We expand on start-up costs in our getting the rental business launched section.

Next example- you’ve identified a nice rental property, and you travel to Miami four different times to a) do an initial walk-through, b) be present for inspections, c) sign-off on a seller repair and contingency and d) final walk-through and closing. The costs associated with these four trips to Miami would be considered acquisition costs (not start-up expenses) and added to the purchased rental property’s cost basis and depreciated accordingly.

Next example- you travel to Miami to look for and purchase another rental property. This is considered a business expansion, and travel expenses are considered operating expenses. This is an important distinction since these expenses are a) not considered start-up expenses which have limitations and b) not added to the purchase price as acquisition costs with the slow tax benefit of depreciation. Rather, they are generally immediately deductible.

Final example- you’ve had your fill of Miami and decided to pursue a rental property in Key West. This is likely to be considered a new business venture and therefore start-up expenses might be leveraged but you also have the downsides of adding acquisition costs to the purchase price and subsequent depreciation. In other words, the travel costs associated with Key West would not be operating expenses like the example above.

As a summary, travel expenditures could be start-up costs, acquisition costs or operating expenses depending on timing, geography and whether you already own a rental property. Here is a table that might be helpful as well-

New Location	Property Identified	Type	Deduction
Yes	No	Start-Up Costs	Deducted (limits)
Yes	Yes	Acquisition Costs	Depreciated
No	No	Operating Expense	Deducted
No	Yes	Acquisition Costs	Depreciated

We expand on all this in our rental property travel deductions section.

What if you never purchase a rental property or make a real estate investment during the tax year? IRS Publication 535 Business Expenses reads in part-

If your attempt to go into business is unsuccessful. If you are an individual and your attempt to go into business is not successful, the expenses you had in trying to establish yourself in business fall into two categories.

1. The costs you had before making a decision to acquire or begin a specific business. These costs are personal and non-deductible. They include any costs incurred during a general search for, or preliminary investigation of, a business or investment possibility.

2. The costs you had in your attempt to acquire or begin a specific business. These costs are capital expenses and you can deduct them as a capital loss.

You have two scenarios here. Let’s look at some examples- you spend $4,000 on a real estate investment course, but you never identify the target business. Meanwhile December 31 comes and goes, and you fall out of favor with real estate. This $4,000 would fall under the first scenario, and therefore would not be deductible.

You identified a rental property, and you spent $4,000 on travel and legal fees. However, the deal falls through and you do not purchase another property. This would fall under the second scenario, and become a capital loss subject to those limitations.

What if you spent $4,000 on travel and legal fees in November, identified your target business or rental property in December, filed your tax returns in February with a nice $4,000 tax deduction because WCG CPAs & Advisors is wicked fast, but the deal falls through in April? Oh boy, a discussion certainly needs to be had. What if another rental property in the same area is identified and purchased?

For fun, let’s go back and spend $4,000 on a real estate investment course. However, you already own and operate a rental property. This could easily be considered an education expense that is tax deductible since it improves your current work skills. If you were launching another rental property purchase or some other real estate business, this same $4,000 could be start-up costs. It’s all a matter of perspective.

How about this one- you already own a nice short-term rental property in Miami but you also are snooping around in Vail. Why not, right? You spend $4,000 on travel and legal fees to check out the area but have not identified the target property to purchase. Time goes by, and you back out of the Vail market. This $4,000 is lost as a tax deduction since you never started your business (purchased a rental property), nor can you consider it an operating expense for your current short-term rental for lack of business connection.

Our apologies for the slight digression.

Meals During Acquisition

In playing off our travel deduction examples in another section, let’s say you’ve identified a nice rental property in Miami. You travel there four different times to a) do an initial walk-through, b) be present for inspections, c) sign-off on a seller repair and contingency and d) final walk-through and closing. You must eat, right?

Assuming that your trips to Miami required overnight rest, or that you met with a business associate (real estate broker or prospective tenant), and happened to eat a meal during the meeting, the meals associated with these four trips to Miami would be considered acquisition costs (not start-up expenses) and added to the purchased rental property’s cost basis and depreciated accordingly.

This aligns with the general premise that a real estate investor or rental property owner might incur costs that facilitate a transaction, and they include such things as commissions, advertising fees, appraisal fees, meals, travel, and professional fees.

Closing Costs

Closing costs are commonly forgotten on rental property setups. Approach this by asking yourself what costs would I have incurred if the purchase was made with cash, and without borrowing. Those costs typically include abstract fees, charges for installing utility services, legal and recording fees, surveys, transfer taxes, title insurance, and any amounts the seller owes that you agree to pay (such as back taxes or interest, recording or mortgage fees, sales commissions and charges for improvements or repairs). This list is straight from the IRS website.

The amounts above are considered acquisition costs and are added to the cost basis of the rental property. Easy.

Loan Costs

What about loan costs? The costs beyond a cash deal? Unlike your primary residence, where you can only deduct qualified points and interest, you can amortize all costs associated with obtaining a new mortgage for your rental property over the life of the loan (usually 30 years). Common loan-related expenses include points, loan origination and loan assumption fees, mortgage insurance premiums, application fees, credit report fees and appraisal fees (if required by the lender).

Quick example. $3,000 in loan-related costs amortized over a 30-year loan would be $100 per year (and therefore deducted). Amortization is similar to depreciation but relates mostly to intangible assets such as goodwill, patents, copyrights, and loan costs.

Be careful of impound and prepaids on the closing disclosure or settlement statement. If you are asked to impound 6 months of mortgage interest or property taxes, these are not loan costs.

Other Acquisition Costs

Here are some more acquisition and closing costs that are commonly overlooked-

• Application fees, and similar expenses.

• Property appraisals and inspections including architectural, engineering, environmental, and geological services.

• Legal and accounting fees including tax advice to review offers, purchase or sales agreements.

• Costs to obtain regulatory approval or secure permits (think short-term rental permits).

• Cost of services provided by a qualified intermediary in a like-kind exchange.