Are Closing Costs Tax Deductible? A Homeowner’s Guide

When purchasing a home, expenses beyond the purchase price, known as closing costs, are paid at the culmination of a real estate transaction. Only certain closing costs offer tax benefits, potentially reducing a homeowner’s taxable income. Understanding which expenses are deductible is important for managing personal finances and tax obligations.

What Closing Costs Are Deductible

Certain closing costs are tax-deductible, potentially reducing a homeowner’s tax liability. These include mortgage interest, real estate taxes, and, at times, mortgage insurance premiums. Deductibility is subject to conditions and limitations set by tax regulations.

Mortgage interest, including prepaid interest known as “points,” can be a significant deduction. Points are generally deductible over the loan’s life. However, points paid to acquire or build a primary residence may be fully deductible in the year paid if certain conditions are met. These conditions include the loan being secured by the home, the payment of points being an established business practice in the area, and the amount not exceeding what is generally charged.

Real estate taxes paid at closing are deductible in the year they are paid. When a home is purchased, property taxes are prorated between the buyer and seller, with the buyer paying their share for the period of ownership. This prorated amount paid at closing can be claimed as a deduction. However, a limitation exists on the total amount of state and local taxes, including real estate taxes, that can be deducted, currently capped at $10,000 per household ($5,000 if married filing separately).

Private Mortgage Insurance (PMI) premiums have historically been deductible, though this deduction has often been temporary and subject to legislative changes. When available, PMI premiums are deductible subject to income limitations and phase-outs, meaning the deduction amount decreases as income rises. The deduction for mortgage insurance premiums expired at the end of 2021 and is not currently available for tax years 2022 and beyond, though efforts are sometimes made to reinstate it.

What Closing Costs Are Not Deductible

Many closing costs are not tax deductible, as they are considered part of the cost of acquiring the property rather than an expense related to the home’s use or an interest payment. Understanding these non-deductible items is important to avoid errors in tax filings.

Loan origination fees, while sometimes confused with deductible points, are not deductible unless they represent prepaid interest that meets the criteria for points. These fees are charged by lenders for processing the loan application and are considered a cost of obtaining the loan. Appraisal fees, which cover the cost of valuing the property, are also not deductible.

Fees paid to attorneys for services related to the closing, such as preparing documents or conducting title searches, are not deductible. Charges for title insurance, which protects the lender and/or owner against defects in the property’s title, are also not tax-deductible.

Other common non-deductible closing costs include recording fees, paid to the local government for property transfer, and home inspection fees for professional home assessment. Credit report fees, for credit history checks, also fall into this category.

Claiming Deductible Closing Costs

Taxpayers seeking to claim deductible closing costs must itemize their deductions on their federal income tax return. Itemizing involves listing specific deductible expenses on Schedule A (Form 1040), rather than taking the standard deduction. Homeowners should compare their total itemized deductions to the standard deduction amount for their filing status to determine which method provides the greater tax benefit.

Several important documents help in identifying and reporting deductible closing costs. The Form 1098, Mortgage Interest Statement, is provided by the mortgage lender and reports the amount of mortgage interest paid during the year, including any deductible points. This form is a primary source for reporting mortgage interest and points on Schedule A.

The Closing Disclosure, or formerly the HUD-1 Settlement Statement, is a comprehensive document received at closing that details all charges and credits in the real estate transaction. This document helps identify amounts paid for real estate taxes and other potentially deductible items, as it provides an itemized list of all closing costs. Taxpayers should review their Closing Disclosure to identify all eligible expenses.

Accurate record-keeping of all closing documents is important for tax purposes. Maintaining copies of the Form 1098 and the Closing Disclosure allows taxpayers to substantiate their deductions if the Internal Revenue Service (IRS) requests verification. These records support the amounts claimed on Schedule A, ensuring compliance with tax regulations.