As per Turbo Tax, Prepayment Penalty is treated as a capital expenditure and is not deductible, however: there are exceptions to this rule:
- A prepayment penalty is incurred in connection with the disposition of a capital property, in which case the penalty is taken into account when calculating the gain or loss from the disposition of that property.
- A prepayment penalty qualifies as an eligible moving expense and is deductible as such.
- A prepayment penalty qualifies as a current expense in the context of a particular business, such as a business of trading in mortgages.
Based on your situation, it is similar to the 1st exception wherein you sold your rental property and a prepayment penalty was made to pay off the balance early. Therefore, you may reduce your capital gains or loss to the prepayment penalty made which would also reduce your taxable capital gains/allowable capital loss.
For more information please see our TurboTax article Tax Treatment of Prepayment Penalties.
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