What Closing Costs Are Tax Deductible When Selling a Home?

Selling a home involves various costs, and understanding their tax treatment is an important consideration for sellers. While many people think of “deductible” as something that directly reduces income, most closing costs incurred when selling a home primarily impact the calculation of capital gain. Navigating these nuances is essential for accurate tax reporting. This article explains how selling costs affect your tax liability and provides guidance on specific costs that can reduce your taxable gain.

How Selling Costs Impact Your Taxable Gain

Most closing costs incurred by a home seller are not direct deductions against ordinary income, unlike mortgage interest or property taxes. Instead, these costs typically reduce the capital gain realized from the sale of the home. Capital gain is the profit from selling an asset, calculated as the selling price minus the adjusted basis and selling expenses. Reducing this calculated gain directly lowers the amount of profit subject to capital gains tax.

Selling costs decrease the net sales price, which in turn reduces the capital gain. For tax purposes, the amount realized from the sale is the selling price less selling expenses. This “amount realized” is then compared to the home’s adjusted basis to determine the capital gain or loss. By reducing the capital gain, sellers can lower their taxable profit or potentially bring their gain within the limits of the home sale exclusion, minimizing or even eliminating their tax liability.

Specific Costs That Reduce Taxable Gain

Several specific closing costs commonly paid by sellers can reduce the taxable gain on a home sale. These costs are generally subtracted from the selling price when calculating the amount realized, effectively lowering the profit subject to capital gains tax.

Real estate commissions are a significant expense for sellers and directly reduce the proceeds from the sale. These fees, typically a percentage of the sales price, are considered selling expenses that lower the capital gain. Legal fees related to the sale, such as those for drafting and negotiating the sales contract, also qualify to reduce the capital gain. Advertising costs incurred to market the property for sale are another eligible expense.

Title insurance premiums paid by the seller, along with transfer taxes and recording fees, are included as selling expenses. These charges are often listed on the closing statement and contribute to lowering the net sales price. Costs of preparing the property for sale, such as staging fees, can also reduce the taxable gain if they are directly tied to the sale. However, these must generally be non-physical improvements and directly related to facilitating the sale.

Additionally, loan-related costs paid by the seller for the buyer, such as points paid to reduce the buyer’s mortgage interest rate, can be treated as an adjustment to the selling price. While the buyer may deduct these points as interest, the seller subtracts them from the sales proceeds, which reduces the seller’s capital gain. Other miscellaneous fees, including appraisal fees, escrow fees, and document preparation fees, often found on the closing statement, also reduce the amount of taxable gain.

Costs Not Affecting Taxable Gain

While many costs are associated with selling a home, not all of them reduce the taxable gain. Certain expenses are not considered selling expenses for tax purposes. Understanding these distinctions helps avoid incorrect tax reporting.

Costs related to obtaining a new mortgage, if the seller is also purchasing a new home, are generally not deductible from the gain on the sale of the old home. These are considered expenses of the new purchase, not the sale. Personal moving expenses, such as the cost of packing and transporting household goods, are also not deductible when calculating capital gain from a home sale.

Costs for general home improvements made over the years do not directly reduce the capital gain at the time of sale, unless they are specifically part of the sales agreement. Instead, these improvements typically increase the home’s cost basis, which indirectly reduces the gain. Property taxes and mortgage interest that were already deducted as itemized deductions on previous tax returns cannot be deducted again as selling expenses. Buyer-specific costs that the seller might mistakenly think apply to them, such as the buyer’s loan origination fees (unless paid by the seller to facilitate the sale), generally do not affect the seller’s taxable gain.

Reporting the Home Sale on Your Tax Return

Reporting a home sale on your tax return involves specific forms and calculations. This process ensures that any capital gain or loss is correctly accounted for. You will typically receive Form 1099-S, “Proceeds From Real Estate Transactions,” from the closing agent, which reports the gross proceeds of the sale to you and the Internal Revenue Service (IRS).

If you receive a Form 1099-S, or if your gain is not entirely excludable, you must report the sale on your tax return. This typically involves Schedule D (Capital Gains and Losses) and Form 8949 (Sales and Other Dispositions of Capital Assets). On Form 8949, you will list the details of the sale, including the date acquired, date sold, selling price, and the adjusted basis. The selling price is the amount reported on Form 1099-S, and the adjusted basis is your original cost plus qualified improvements.

After accounting for selling expenses, the calculated gain or loss from Form 8949 is then transferred to Schedule D. The home sale exclusion allows you to exclude up to $250,000 of gain from your income if single, or up to $500,000 if married filing jointly. To qualify for this exclusion, you generally must have owned and used the home as your main home for at least two out of the five years before the sale. If your gain exceeds the exclusion amount, the excess is taxable as a capital gain.

Documenting Your Selling Expenses

Maintaining thorough records of your selling expenses is important for substantiating any reported costs. These documents are essential for accurately calculating your capital gain and for future reference, especially in the event of an IRS inquiry or audit.

Key documents to retain include the settlement statement, also known as the Closing Disclosure or HUD-1 statement. This document itemizes all the costs incurred by both the buyer and seller during the transaction. Invoices and receipts for services directly related to the sale, such as advertising, staging, or minor repairs specified in the sales agreement, should also be kept.

Real estate commission agreements and any other contracts detailing fees paid to agents or brokers are important records. Documentation of transfer taxes, recording fees, and any seller-paid points should also be saved. It is advisable to keep these records for at least three to seven years after filing the tax return for the year of the sale, as the IRS can audit returns for several years. Organizing these documents in a secure manner can simplify tax preparation and provide necessary proof if questions arise.