Which Closing Costs Are Deductible on a Sale and Reduce Your Gain

Selling costs reduce the amount realized rather than being deducted

Reg. section 1.263(a)-1(e) says commissions and other transaction costs paid to facilitate the sale of property are not currently deductible. They are capitalized costs that reduce the amount realized in the year of the sale, and they are not added to the basis of the property sold. The regulation's example is a sale of real estate with legal fees, recording fees and sales commissions, all of which reduce the amount realized.

The result is the same dollar-for-dollar reduction in gain as a deduction, but the character follows the sale: a lower capital gain or section 1231 gain, not an ordinary deduction. A dealer in real estate is the exception; the regulation lets a dealer deduct the same costs as ordinary business expenses.

Publication 544 shows the arithmetic in its building-sale example: cash, the value of property received, liabilities the buyer assumes and real estate taxes the buyer assumes add up to the total, and selling expenses are subtracted to reach the amount realized.

The seller-side lines that count as selling expenses

Publication 523 lists selling expenses as sales commissions, advertising fees, legal fees, mortgage points or other loan charges you paid that would normally have been the buyer's responsibility, and any other fees or costs to sell. It adds that transfer taxes, stamp taxes and similar charges you pay as the seller are treated as selling expenses, not deductible taxes.

On a typical settlement statement that means the listing and buyer's broker commissions, your attorney's fee, escrow or settlement fees you pay, the owner's title policy if your contract makes it the seller's cost, deed preparation and recording fees, and state or local transfer or deed taxes you pay. The Form 8949 instructions describe net proceeds the same way: gross proceeds less selling expenses such as broker's fees, commissions and state and local transfer taxes.

Costs you paid when you bought the property belong to a different calculation. Those go into your basis, and the settlement statement page shows how both sides of the statement are read.

Payoffs, prorations and deposits are not selling expenses

Repaying your mortgage from the proceeds is repayment of your own debt. It does not reduce the amount realized, and if the buyer assumes the loan instead, Publication 544 adds the assumed debt to the amount realized. Fees to obtain or pay off your own financing are financing costs, not costs of selling. Publication 936 treats a prepayment penalty on a home mortgage as deductible mortgage interest.

Property tax prorations follow section 164(d): the tax for the part of the year ending the day before the sale is treated as imposed on the seller, and the rest on the buyer. Your share is a tax you deduct, on Schedule E for a rental, while taxes the buyer pays on your behalf are added to your sale price under Publication 523.

Rent you collected in advance and security deposits you hand to the buyer are tenant items, not selling costs; the page on security deposits and rent prorations explains how they affect an exchange.

A worked example: reading an $800,000 settlement statement

Hypothetical, round numbers. You sell a rental for $800,000. The seller's column shows a $40,000 commission, $8,000 of transfer tax you owe as seller, $3,000 of title and escrow charges, a $2,000 attorney's fee and $200 of recording fees. It also shows a $300,000 loan payoff, a $4,000 property tax proration credit to the buyer, $2,500 of prepaid rent and $3,000 of security deposits transferred to the buyer.

Selling expenses are $53,200, so the amount realized is $746,800. The loan payoff, rent and deposits do not change it. Your share of the property tax is deducted as a rental expense for the year rather than subtracted from the price. If your adjusted basis is $300,000, the gain is $446,800.

Run your own numbers with your CPA, because the treatment of each credit depends on how your contract allocates it.

How to report selling costs, and what changes in an exchange

For business or rental property, Form 4797 asks for cost or other basis plus expense of sale, so selling expenses are added in that column. For personal-use property reported on Form 8949, enter the proceeds shown on the Form 1099-S and, if selling expenses are not already reflected, enter code E and the adjustment in column (g).

In a 1031 exchange, the same selling costs reduce the gain realized, and the treatment of each item paid from exchange funds matters. The pages on closing costs paid from exchange funds and on whether exchange fees are deductible or added to basis cover the line-by-line rules. For a second home, see taxes when selling a second home.