Are Closing Costs Added to Basis for Tax Purposes?
Understand which closing costs can be added to your property's basis for tax purposes and how proper record-keeping can impact future tax calculations.
When buying real estate, closing costs add up quickly. These expenses cover various fees required to finalize the purchase, but not all affect your tax situation. A key consideration is whether certain closing costs can be added to the property’s basis, which impacts capital gains taxes when you sell.
Understanding how these costs factor into your property’s basis can help you make informed decisions and reduce future tax liabilities.
Types of Fees Potentially Added to Basis
Some closing costs can be included in the property’s basis, which affects capital gains when sold. These costs generally relate to acquiring ownership rather than financing or ongoing maintenance.
Transfer or Stamp Taxes
Transfer taxes, also called stamp or deed taxes, are government-imposed fees on real estate transactions. These taxes vary by location and are often calculated as a percentage of the sale price. For instance, New York State charges a basic real estate transfer tax of 0.4% of the purchase price, while New York City imposes additional taxes based on property value.
Because these taxes are required to transfer ownership, the IRS allows them to be included in the property’s basis. This reduces taxable gains when the property is sold. Buyers should keep documentation, such as tax receipts or closing statements, to support the inclusion of these fees in their basis calculations.
Title Charges
Title-related fees cover the legal process of verifying property ownership and ensuring no outstanding claims or liens exist. Common title charges include title search fees, the cost of an owner’s title insurance policy, and legal fees for clearing title defects.
The IRS considers these costs part of the acquisition process, meaning they can be added to the property’s basis. For example, if a buyer pays $1,500 for a title search and $2,000 for an owner’s title insurance policy, those amounts increase the property’s basis. However, lender’s title insurance, which protects the mortgage lender, is not included. Buyers should review their closing disclosure to separate basis-eligible title costs from loan-related expenses.
Recording or Filing Fees
Recording fees are government charges for officially documenting a property’s deed, mortgage, and other legal documents in public records. These fees vary by jurisdiction and are necessary to establish legal ownership. In California, recording a property deed may cost between $14 and $18 per page, depending on the county.
Since these fees are necessary to secure property rights, they can be added to the property’s basis. Filing fees for legal documents, such as affidavits of property value or survey certifications, may also qualify. Buyers should retain copies of recorded documents and receipts from the county recorder’s office to verify these expenses when adjusting their basis.
Fees Typically Excluded from Basis
Not all closing costs contribute to the property’s basis. Expenses related to loan origination, prepaid items, and certain professional services are generally excluded because they pertain to financing or ongoing ownership rather than acquisition.
Loan origination fees, or points, are charges paid to the lender for processing the mortgage. These fees, typically expressed as a percentage of the loan amount, are considered a cost of borrowing rather than purchasing the property. For example, if a borrower pays 1% in loan origination fees on a $300,000 mortgage, the $3,000 expense is not added to the basis. Instead, points may be deductible in the year paid or amortized over the loan’s lifetime, depending on IRS rules.
Prepaid interest and property taxes collected at closing are also excluded. Lenders often require buyers to prepay mortgage interest for the period between closing and the first scheduled payment. Similarly, prorated property taxes cover the seller’s portion of taxes owed up to the closing date. These amounts relate to future expenses rather than the acquisition cost, so they are deductible in the year paid but do not affect the property’s basis.
Homeowners insurance premiums and private mortgage insurance (PMI) must also be paid at closing but do not qualify for basis adjustments. Homeowners insurance protects against property damage, while PMI is required for loans with lower down payments. These expenses are part of ongoing homeownership rather than the purchase price and cannot be added to the basis.
Property Improvements and Basis Adjustments
A property’s basis can change over time when money is spent on improvements that add value, extend its useful life, or adapt it to a new use. The IRS allows these capital improvements to be added to the basis, which can lower taxable gains when the property is sold. Routine repairs, however, do not qualify.
Expanding a home or upgrading major systems are common basis-adjusting improvements. Adding a new bedroom or bathroom, finishing a basement, or building a garage increases the property’s value and can be included in the adjusted basis. Similarly, replacing an entire roof, upgrading an HVAC system, or installing solar panels qualifies because these changes enhance the property’s functionality and longevity. The Inflation Reduction Act of 2022 extended tax credits for energy-efficient home improvements through 2032, meaning some of these upgrades may also provide immediate tax benefits.
Landscaping and exterior enhancements can also affect the basis. Installing an in-ground pool, constructing a retaining wall, or paving a driveway are capital improvements because they add to the property’s overall worth. However, general landscaping maintenance, such as mowing the lawn or replacing plants, does not count. The distinction lies in whether the change permanently improves the property rather than simply keeping it in good condition.
Keeping Records for Tax Purposes
Maintaining thorough documentation is necessary for accurately determining a property’s basis and ensuring compliance with IRS guidelines. The burden of proof falls on the taxpayer when reporting capital gains, so keeping organized records can prevent disputes and reduce the risk of unexpected tax liabilities.
Settlement statements, such as the Closing Disclosure or HUD-1, provide a breakdown of costs incurred during the purchase, making them fundamental documents to retain. These forms itemize expenses that may be included in the basis, such as legal fees, survey costs, and recording charges, and serve as primary evidence if the IRS requests substantiation.
Beyond the initial purchase, retaining receipts, invoices, and contracts for improvements ensures that basis adjustments are properly documented. The IRS does not accept estimates or unsupported claims, meaning detailed records must clearly identify the nature of the work, the date of completion, and the amount paid. For example, if a homeowner installs a geothermal heating system, retaining the contractor’s invoice and proof of payment verifies the expenditure for both basis adjustments and potential energy tax credits under Internal Revenue Code 25D.