Taxation and Regulatory Compliance

Are Closing Costs Deductible on Taxes?

Demystify how real estate closing costs affect your taxes. Explore their varied impact on your immediate and future financial standing.

When buying or selling real estate, various fees and charges known as closing costs are incurred. The tax deductibility of these costs can be complex. Some closing costs offer immediate tax deductions, while others adjust your home’s cost basis, providing a tax benefit later. Understanding these distinctions helps homeowners navigate their tax obligations effectively.

Identifying Deductible Closing Costs

Certain closing costs are directly deductible in the tax year they are paid, offering an immediate tax advantage. A significant deductible cost is mortgage interest, including prepaid interest often referred to as points. If points are paid to obtain a mortgage for your principal residence, they are generally deductible in the year paid, provided the loan is secured by the home, paying points is an established practice in your area, and the amount is not excessive. The deduction for mortgage interest is capped at $750,000 of indebtedness for loans originated after December 15, 2017, or $1 million for earlier loans. If these conditions are not met, or for points paid on a refinance or second home, the deduction may need to be spread over the life of the loan.

Real estate taxes paid at closing are also generally deductible in the year they are paid. These amounts are typically itemized on your Closing Disclosure (CD) or HUD-1 settlement statement. The deduction for state and local taxes, including real estate taxes, is limited to $10,000 per household ($5,000 if married filing separately). Private mortgage insurance (PMI) premiums are not currently available for 2024 or 2025.

These deductions are generally applicable only if you itemize deductions on your tax return, rather than taking the standard deduction. The timing of the payment is crucial; costs are deductible in the tax year they are actually paid to the appropriate party, not necessarily when the loan officially closes.

Closing Costs That Adjust Your Home’s Basis

Many closing costs not immediately deductible can still provide a tax benefit by increasing your home’s cost basis. The cost basis of your home is its original cost plus the cost of certain improvements and specific closing expenses. This adjusted basis reduces the amount of taxable capital gain when you eventually sell the property. A higher basis means a smaller profit, potentially lowering your capital gains tax liability.

Closing costs that typically add to your home’s basis include abstract fees, appraisal fees, and legal fees related to acquiring title or preparing the sales contract and deed. Recording fees, survey fees, and transfer taxes also increase the basis. Additionally, the cost of owner’s title insurance and charges for installing utility services are generally added to the basis.

Costs associated with obtaining a loan, such as mortgage insurance premiums or loan assumption fees, generally cannot be added to the basis. Understanding which costs adjust your basis is crucial for long-term tax planning, especially when considering a future sale of your home.

Reporting Closing Cost Deductions

Reporting deductible closing costs on your tax return involves specific documentation and tax forms. The Closing Disclosure (CD) or the HUD-1 settlement statement is the primary document to identify the various fees paid at closing. For mortgage interest and points, lenders typically issue Form 1098, which reports the amount of interest and points paid during the year.

Mortgage interest and qualifying points are reported on Schedule A (Form 1040), Itemized Deductions. Amounts reported on Form 1098 are entered on line 8a, while any deductible points not included on Form 1098 are reported on line 8c. Real estate taxes paid are also reported on Schedule A, typically on line 5b.

It is crucial to remember that these deductions are only beneficial if your total itemized deductions exceed the standard deduction for your filing status. For tax year 2024, the standard deduction is $14,600 for single filers and $29,200 for married couples filing jointly. Keeping accurate records, including your Closing Disclosure and Form 1098, is essential for substantiating these deductions.

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