When you purchase your home or buy land for your new home from a seller, you are responsible for paying closing costs on top of the negotiated contract price. These costs can be shared by the seller depending on the negotiations.
As you sign the dotted line, you might be wondering whether closing costs are tax-deductible. The IRS has specific rules for many other tax-related issues, so it’s no surprise that it also has rules for itemized deductions for homeowners and deducting real estate closing costs. Here’s what you need to know about the IRS rules for deducting closing costs, so you’ll be prepared when you file your taxes.
Are Closing Costs Deductible?
Tax deductions for homeowners aren’t always easy to calculate, but the IRS does break down what types of tax deductions you can take when filing Form 1040. The only way to deduct closing costs, such as property tax or a settlement fee, is by reporting them as itemized deductions. You can’t take a standard deduction and also deduct your closing costs, so you have to decide which one offers the most tax advantages when filing your return.
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Deductible Home-Closing Costs
Eligible home-closing costs must be deducted in the year you buy your home. According to the IRS, the only closing costs you can deduct are:
- Home mortgage interest paid at settlement — found on the mortgage interest statement provided by the lender.
- Certain real estate taxes paid at closing.
- Real estate taxes the lender paid from escrow to the taxing authority, which are listed on your real estate tax bill.
- Sales taxes paid at closing.
- Points: In general, you can only deduct points over the life of mortgage, but exceptions exist.
- Mortgage insurance premiums — except for mortgage insurance provided by the Department of Veterans Affairs or Rural Housing Service.
About Deducting Points
Points, aka loan origination fees, are sometimes eligible to deduct in the year you purchased the home or land. But first, you must meet the criteria set forth by the IRS:
- The loan is for your main residence.
- Paying points is typical in the area where you get your loan.
- You didn’t pay more than the points typically charged in your area.
- You use the cash method of accounting.
- The points were not paid in lieu of paying other fees, such as appraisal fees, inspection fees, title orders, fees for an attorney or property taxes.
- The money you paid at or before closing, plus any points the seller paid, were at least the equivalent of the points charged.
- You used your loan to buy or build your main residence.
- The points were calculated as a percentage of the principal amount of the mortgage.
- The amount of points charged for the mortgage is clearly shown on the settlement statement.
Non-Deductible Closing Costs
There are several settlement costs and closing costs you cannot deduct or add to the basis of your home. The following closing costs are not tax-deductible:
- Cost of your fire insurance premiums
- Charges you had for using utilities or services if you occupied the home before closing
- Rent you paid if you moved into the home before closing
- Charges associated with getting or refinancing a mortgage loan, such as costs for ordering credit reports, loan assumption fees or lender-ordered appraisal fees
Even though you are permitted to deduct some types of real estate taxes, you cannot deduct the following types:
- Itemized charges for services, even if the charge is paid to the taxing authority
- Taxes for local benefits that increase the value of your property
- Transfer taxes or stamp taxes
- Homeowners association assessment costs
How to Deduct Home Closing Costs
To deduct certain types of expenses related to the closing, you’ll need to use the correct tax form: Form 1040, lines 6 through 13.
Here’s the breakdown of where to report different closing costs:
- Real estate taxes: Line 6
- Home mortgage interest and points reported on Form 1098: Line 10
- Home mortgage interest not reported on Form 1098: Line 11
- Points not reported on Form 1098: Line 12
- Qualified mortgage insurance premiums: Line 13
Some of your closing costs are tax-deductible, so it pays to know what expenses you can deduct as itemized deductions come tax time. Keep in mind that if your total itemized deductions for the year are less than the standard deduction, it doesn’t make financial sense to deduct closing costs. Consider working with an accountant or tax professional to make sure you are reporting all of your real estate taxes accurately and deducting expenses that are acceptable by the IRS.
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