Purchasing a home is a significant financial undertaking, and closing costs can add a substantial expense to the process. However, some of these costs may offer tax benefits, reducing your overall tax burden. Understanding which closing costs are tax-deductible can help you maximize your savings and make informed decisions when buying a home.

Understanding Tax Deductions

Tax deductions allow you to reduce your taxable income, resulting in lower taxes. When itemizing deductions, you can subtract eligible expenses from your income before calculating your tax liability.

Tax-Deductible Closing Costs

The Internal Revenue Service (IRS) permits homeowners to deduct certain closing costs incurred when purchasing or refinancing a home. These deductible costs fall into three categories:

1. Deductible in the Year Paid

• Mortgage Points: Fees paid to lower the interest rate on a mortgage loan, known as “points,” are deductible in the year of payment if specific criteria are met:
  • The loan must be used to purchase or build a primary residence.
  • Paying points must be customary in the area where the loan is made.
  • The amount paid for points must be reasonable for the area.
  • The taxpayer must use the cash method of accounting.
  • The points cannot be paid in lieu of other closing costs.
  • The taxpayer or seller must pay the points.
  • The loan must be secured by the primary residence.
  • The points must be calculated based on the loan’s principal amount.
  • The amount paid for points must be shown on the closing disclosure or settlement statement.
• Mortgage Insurance Premiums: Private mortgage insurance (PMI) premiums paid on loans with a down payment of less than 20% may be deductible.
• FHA Mortgage Insurance and VA Funding Fees: Upfront and annual mortgage insurance premiums for FHA loans and VA funding fees for VA loans may be deductible.

2. Deductible Over the Life of the Loan

• Points Paid on a Purchase Loan: If the criteria for deducting points in the year paid are not met, a portion of the points may still be deductible over the life of the loan.
• Points Paid on a Home Improvement Refinance Loan: Points paid on a refinance loan used for home improvements may be deductible over the remaining loan term.

3. Deductible When Selling Your Home

• Owner’s Title Insurance: The cost of owner’s title insurance can be added to the basis of your home, reducing the capital gains tax you pay when you sell.
• Property Taxes: If you paid any portion of the seller’s property taxes when you purchased your home, you can add this amount to your basis.
• Title Fees or Abstract Fees: These costs can also be added to your basis.
• Legal and Recording Fees: Fees for preparing contracts, deeds, and recording the transaction can be added to your basis.
• Survey Fees: Fees for confirming the property’s boundaries can be added to your basis.
• Utility Installation Charges: Costs for installing utilities on your property can be added to your basis.
• Transfer or Stamp Taxes: These taxes vary by state, but if you pay them, they can be added to your basis.

Non-Deductible Closing Costs

Not all closing costs are tax-deductible. The following expenses are not eligible for tax deductions:

• Homeowners insurance premiums
• Monthly principal payments
• Utility costs (gas, water, electric)
• Home appraisal fees
• Notary fees
• Document preparation fees

Finding Closing Cost Information

To identify tax-deductible closing costs, refer to your closing disclosure. This document provides a detailed breakdown of all closing costs associated with your mortgage loan.

Understanding which closing costs are tax-deductible can help you optimize your tax savings and make informed financial decisions. By deducting eligible expenses, you can reduce your taxable income and maximize your tax benefits. Consult with a tax professional for personalized guidance and to ensure compliance with the latest tax laws.