Are Real Estate Escrow Fees Tax Deductible?
Clarify the tax deductibility of real estate escrow fees and associated expenses. Learn the rules for personal and investment properties.
Clarify the tax deductibility of real estate escrow fees and associated expenses. Learn the rules for personal and investment properties.
Real estate transactions involve numerous costs, and among them are escrow fees, which often lead to questions about their tax deductibility. An escrow account acts as a neutral third party, holding funds and documents until all transaction conditions are met, providing security for both buyers and sellers.
For most individuals purchasing a personal residence, the direct fee charged for escrow services is not tax deductible. These fees are considered personal closing costs, part of the home’s acquisition expense. Escrow service fees compensate the escrow agent for managing the transaction, including document preparation, fund disbursement, and ensuring terms are met.
Common escrow service fees in this non-deductible category include settlement fees, closing fees, document preparation fees, and notary services. While necessary, tax authorities generally view these fees as part of the property’s acquisition cost, not an annually deductible expense.
These service fees differ from other costs paid through an escrow account. The non-deductibility applies specifically to the escrow agent’s compensation. Many other expenses are channeled through escrow for convenience, but their deductibility depends on the expense’s nature, not the payment method.
While the fee for the escrow service itself is not deductible for a personal residence, other expenses commonly paid through escrow are deductible. These underlying expenses can offer significant tax benefits, as deductibility hinges on the expense type, not the payment mechanism.
Property taxes, often managed through escrow, are deductible as state and local taxes (SALT). Homeowners can deduct property taxes paid during the tax year, whether directly or through an escrow account. The total deduction for state and local taxes, which includes property taxes, is subject to an annual limitation, currently set at $10,000 ($5,000 if married filing separately) through 2025.
Mortgage interest is another major deductible expense frequently paid via escrow. Interest paid on a home mortgage is deductible, up to a loan amount of $750,000 ($375,000 for married individuals filing separately) for loans after December 15, 2017. A higher limitation of $1 million ($500,000 for married filing separately) applies for mortgages originated before this date. This deduction applies to interest paid on loans secured by a main home or a second home.
Mortgage insurance premiums (MIP or PMI) were deductible in certain past tax years, often required when a down payment is less than 20%. However, this deduction expired at the end of 2021 and is not available for tax years 2022 and beyond.
The tax treatment of escrow fees changes when the property is used for investment or business purposes. For these properties, escrow service fees, unlike for personal residences, can be deductible as ordinary and necessary expenses incurred in operating a business or managing an investment.
For rental properties, many closing costs, including certain escrow fees, can be deducted. Some costs, like prorated real estate taxes and prepaid mortgage interest, may be immediately deductible. Other escrow-related costs, such as abstract, legal, recording, survey, and title insurance fees, are generally added to the property’s cost basis. This basis can be recovered through depreciation or reduce taxable gain upon sale.
If a portion of a personal home is used exclusively for business, a pro-rata share of certain expenses, including some escrow-related costs, may be deductible. These deductions fall under business expense rules. For investment or business use, fees are connected to income-producing activity, allowing different tax treatment than personal use.
Taxpayers must report deductible real estate expenses paid through their escrow account on their federal tax return. The primary method for claiming these deductions is by itemizing on Schedule A (Form 1040). Itemizing provides a tax benefit if total itemized deductions exceed the standard deduction for the taxpayer’s filing status.
For mortgage interest, taxpayers receive Form 1098, Mortgage Interest Statement, from their mortgage servicer by January 31. This form reports the total mortgage interest paid. Box 1 of Form 1098 shows the deductible mortgage interest.
Property taxes paid through escrow are typically reported on Form 1098, Box 4, or on the annual escrow statement. Deduct only the amount of property taxes the lender paid to the taxing authority, not merely the amount deposited into escrow. The deduction for state and local taxes, including property taxes, is subject to the $10,000 limitation ($5,000 if married filing separately).
For investment or business properties, deductible expenses are generally reported on Schedule E (Supplemental Income and Loss). Business-related home office expenses may be reported on Schedule C (Profit or Loss from Business). Maintaining accurate records, including the Closing Disclosure statement and annual escrow statements, is important for substantiating deductions.