Are Real Estate Closing Costs Tax Deductible?

When purchasing real estate, closing costs represent various fees and expenses incurred at the final stage of the transaction. While these costs can be substantial, their tax treatment varies significantly. Some closing costs may offer immediate tax deductions, while others contribute to the property’s cost basis, impacting future tax obligations upon sale. Understanding these distinctions helps homeowners with financial planning.

Directly Deductible Closing Costs

Certain closing costs incurred when buying a home can provide immediate tax benefits through direct deductions in the year of purchase. These typically include specific types of mortgage interest and real estate taxes. These deductions are generally available to taxpayers who itemize deductions on Schedule A of Form 1040.

This includes prepaid interest, or “points,” paid to a lender for a home mortgage. For a home purchase, points are generally fully deductible in the year paid if the loan is secured by the main home, points are customary, and the amount does not exceed typical charges. Additionally, any daily interest paid from the closing date up to the first mortgage payment is also deductible. The deduction for home mortgage interest is limited to interest on the first $750,000 of mortgage debt for loans taken out after December 15, 2017, or $1 million for loans originated before this date.

Real estate taxes paid at closing are also deductible. Property taxes are generally deductible in the year they are paid. When a property is purchased, real estate taxes are typically prorated between the buyer and seller based on the portion of the tax year each owned the home. The buyer can deduct their share of these prorated taxes, as long as they are assessed uniformly and used for general governmental purposes. However, the total deduction for state and local taxes, including real estate taxes, is limited to $10,000 per household ($5,000 if married filing separately).

Historically, mortgage insurance premiums (MIP or PMI) were also deductible for some taxpayers. However, this deduction has expired. While past efforts have been made to reinstate this deduction, it is not currently available.

Closing Costs That Add to Your Basis

Many closing costs are not directly deductible in the year of purchase but are instead added to the property’s cost basis. The cost basis is your investment in the property for tax purposes, calculated as the original purchase price plus certain allowable costs and improvements. An accurate cost basis reduces the amount of taxable gain when the property is eventually sold.

Closing costs that increase your property’s basis include fees related to securing the title and transferring ownership. Examples are abstract fees, which cover the cost of a title search, and appraisal fees, charged to determine the property’s value. Recording fees, paid to the local government to officially record the deed and mortgage, are also added to basis. Legal fees, particularly those for title examination or preparing the sales contract, contribute to the basis as well.

Other costs added to basis include survey fees, title insurance premiums, transfer taxes, and loan origination fees (if not treated as deductible points). While these costs do not offer an immediate tax deduction, they provide a long-term tax advantage by lowering the capital gain that may be subject to tax upon the property’s future sale.

Closing Costs for Refinancing and Investment Properties

The tax treatment of closing costs differs when refinancing a loan or purchasing an investment property compared to buying a primary residence. These scenarios have specific rules regarding deductibility and capitalization.

For refinancing a home, points paid are not fully deductible in the year they are paid. Instead, these points must be amortized, meaning they are deducted incrementally over the entire life of the loan. If the refinanced loan is later paid off early, any remaining unamortized points may be deductible in the year the loan is satisfied. Other closing costs associated with a refinance, such as appraisal fees or legal fees, are not deductible and do not add to the property’s basis.

When acquiring an investment property, such as a rental property, many closing costs are treated differently. Mortgage interest and real estate taxes related to a rental property are deductible as business expenses in the year they are paid. Other non-deductible closing costs, similar to those for a primary residence, are added to the property’s basis. However, for investment properties, these capitalized costs can then be recovered through depreciation deductions over the property’s useful life. This allows for a portion of the cost, including relevant closing costs, to be deducted each year, providing ongoing tax benefits.