Accounting for property purchases is one of the more complex transactions in rental property accounting, but it’s vital for ensuring that you have the right basis for depreciation, future capital gains, or 1031 exchanges. There are also several expenses on your closing statement that can be immediately expensed and deducted.
Here is an illustrative example of how to account for a property purchase.
- Begin with the purchase price of the property.
- Identify capitalizable closing costs. These are costs to close that the IRS has determined should be added to the purchase price and depreciated over time, vs being expensed immediately. These include items like title fees, title insurance, surveys, recording fees, and legal fees.
- Split the cost of the property between land and building value. Usually this is broken out on your property tax assessment. This is important because the building value depreciates, but the land doesn’t.
- Identify tax deductible expenses from the closing statement. These include property taxes, prepaid mortgage interest, HOA fees, and insurance.
- Calculate the capitalized closing costs of the mortgage. Similar to capitalized closing costs, mortgages have closing costs that need to be capitalized as well. These can include loan origination/processing/underwriting fees, purchased points, appraisals required by your lender, and credit reports.
- If you had to prefund escrow for items like property taxes, insurance, or mortgage insurance, identify the total of these amounts.
- Identify how much you paid in earnest money deposits that are being credited to you in this transaction.
- Lastly, identify the cash to close.
Example Scenario
For a purchase with the following characteristics:
- $120,000 purchase price
- 20% ($24,000 down)
- 80% ($96,000) in mortgage
- 3% ($3,600) Earnest money deposit
- Closing Costs:
- $2,000 in loan closing costs (loan processing fees)
- $3,000 in non loan closing costs (title insurance, legal fees)
- $1,000 in property insurance paid at closing
- $600 in property taxes paid at closing
- $500 in mortgage interest due at closing
Example Journal Entry
The journal entry in Azibo would be:
| Account Type | Category | Debit | Credit | Notes |
| Assets: Fixed Assets | Buildings & Other Depreciable Assets: Buildings | $100,000 | Building value | |
| Assets: Fixed Assets | Land: Land | $20,000 | Land value | |
| Assets: Fixed Assets | Non-loan Closing Costs | $3,000 | Capitalized non-loan closing costs | |
| Expenses: Operating Expenses | Insurance: Rental Dwelling Insurance | $1,000 | Insurance paid at closing | |
| Expenses: Operating Expenses | Taxes: Property Taxes | $600 | Taxes paid at closing | |
| Assets: Fixed Assets | Capitalized Loan costs: Loan / Refi Closing Costs | $2,000 | Capitalized loan closing costs | |
| Assets: Current Assets | Other Current Assets: Escrow | $1,000 | Contribution to escrow at closing | |
| Expenses: Non-operating expenses | Mortgages & Loans: Mortgage Interest | $500 | Mortgage interest paid at closing | |
| Equity: Owner’s Equity | Owner’s Equity: Owners Contributions | $28,500 | Cash to close | |
| Assets: Current Assets | Other Current Assets: Earnest Money Deposits Paid | $3,600 | Earnest money already paid and credited back at close | |
| Liabilities: Long Term Liabilities | Mortgages & Loans: Mortgage Balances | $96,000 | Mortgage balance | |
| Totals | $128,100 | $128,100 |