Closing Costs For Rental Property

[Michael P.]

My question is, as you acquire a property you obtain a significant hit with closing costs.  How do you roll that into your monthly, or annual breakdown for net profit?

[Mike Dymski]

Originally posted by @Michael P.:

So how do you break it down to make sense of it monthly or annually for your ledger. 

I am in the middle of buying 2 properties, and it sticks bringing around 11k to the table.  Paying 12 moths of tax, and so forth throw my numbers off, with other associated fees.

I see...you are talking escrows.  Escrowed property taxes less prorated taxes credited to you at closing go into a Prepaid Asset account on the balance sheet.  You then reduce that Prepaid Asset account over the tax period by taking a monthly hit to Property Tax Expense on the P&L.  If your mortgage payments require escrowed property taxes, that portion of your monthly payment should be charged to the Prepaid Asset account as well.  When the lender pays the actual taxes, you adjust the Prepaid Asset account to the balance on your escrow statement and the difference goes to Property Tax expense (usually a small annual adjustment between the original estimate and the actual amount paid).

Most people likely do not follow the process above and do one of two things (1) let their accountant handle it all or (2) have their monthly mortgage payment go directly to property tax expense.  The escrowed taxes that went into the Prepaid Account on the balance at closing do not get expensed or adjusted annually and the Prepaid balance just carries forward indefinitely (and is a close approximation of the actual escrow balance).

I take other closing costs to the P&L as a one-time hit at origination (lender fees, attorney fees, appraisal, etc.). You can park them in a Prepaid Asset account on the balance sheet as well and expense them over some extended period but that just creates noise in numerous periods rather than noise in one period. They are not a part of NOI like property taxes are (but they are a part of the initial cash outlay for return calculations...cash-on-cash, ROI, IRR.

Hope that helps.