Are Closing Costs on your Mortgage Tax Deductible?
Buying a house is expensive. Even with a loan, you will still have to make a substantial down payment (depending on the type of loan you take out). On top of that, there are numerous closing costs that you will need to pay for. Fortunately, you can offset some of these costs by writing them off on your taxes. Just keep in mind that when it comes time to file your taxes, you won’t be able to deduct your closing costs if you take the standard deduction. If you want to write off your closing costs, you will need to itemize your deductions. Of course, you need to know which mortgage closing costs are tax-deductible and which aren’t.
Which Particular Closing Costs are Tax-Deductible?
The IRS does have a list of home closing-related deductions that you can take when you file your Form 1040. The following are the closing costs that you can claim as itemized deductions:
Sales tax exists on everything from books to real estate. However, many states make an exception for real estate purchases due to how much money this could add up to. Do your research for your state, since some states do not require buyers to pay sales tax on homes and some do. If you do have to pay a sales tax, you can write it off.
Real Estate Taxes
In addition to a potential sales tax, you will also have to pay real estate taxes or property tax. You are required to pay this to the county you’re located in on a yearly basis. This means that the seller has likely paid the property tax for the year in which you are buying the property. As a result, you will need to reimburse the seller for the real estate tax from the date you close to the end of the property tax billing cycle that the seller has already paid for.
Charged to Home Buyer at Closing
In some cases, you’ll be required to pay for the real estate taxes you owe at closing. If this is the case, you will be able to write off the entire amount.
Paid For by the Mortgage Lender
In other cases, your lender may roll what you owe into your monthly mortgage bills. This means that you will be paying for your real estate taxes on a monthly basis. You can still write these real estate taxes off, but you will need to do a little math since you can only write off the amount that you’ve paid towards the real estate tax. For example, if you only make three mortgage payments before the end of the year, then you can only write off three months of real estate taxes for that year.
The Interest Paid at Purchase
Since most lenders will require that you make a mortgage payment by the first of each month, you may have to prepay interest for the first partial-month of your loan. For example, if you close on the 15th of September, you will have to prepay interest for the remaining 15 days at the closing. This interest can be deducted.
In addition to your prepaid interest, you’ll also be able to write off the interest you pay in total on the mortgage payments you make every year. You can also write off any points that you purchase at the closing, the loan origination fees that you have to pay at the closing, and potentially the mortgage insurance that you pay every month (if you’re required to pay for mortgage insurance and depending on when you purchased the mortgage insurance).
Mortgage Insurance Premiums
If you paid less than 20 percent for your down payment at the closing of your house, then you will most likely be required to pay for mortgage insurance. Unfortunately, the mortgage insurance deduction expired at the end of 2018 and Congress has not renewed it. This means that you can only deduct your mortgage insurance if you purchased your insurance contract between 2013 to 2018. Additionally, if your adjusted gross income is over $109,000 or you’re married (and you file separately) and you make $54,500, then you’re not eligible for a mortgage insurance deduction no matter when you purchased the insurance.
Loan Origination Fees or Points
The loan origination fee is charged by the lender for processing the loan (which includes helping you with your application, checking your credit history, preparing all of your documents, verifying all information, and underwriting the loan). You’re paying your lender this fee for their services. Most loan origination fees are between 0.5 and 1 percent of the home’s purchase price. However, the fee is typically expressed in points. Each point represents one percentage of the purchase price. This means that if you are charged a 1 percent origination fee, you will be required to purchase one point. These points are tax-deductible.
Guide For When Filing your Annual Income Tax Return
Knowing what closing costs you can deduct on your income tax return will be very helpful. Once you understand what you can deduct, use these tips to fill out your annual income tax return:
Explore Itemized Deductions
Before you decide to itemize your deductions, compare the amount of the closing costs that you can write off compared to the standardized deduction and choose whichever allows you to write off a larger amount. If you’ll be able to deduct more through itemized deductions, then fill out an IRS form 1040. Other forms, such as Form 1040EZ, won’t let you itemize deductions, which means you can’t claim any tax benefits. A more detailed breakdown of where to itemize your closing cost deductions on your tax form follows:
- Use line 1 for qualified mortgage insurance premiums.
- Use line 6 for real estate taxes.
- Use line 10 on Form 1098 for home mortgage interest and points.
- Use line 1 for home mortgage interest not reported on Form 1098.
- Use line 12 for points not reported on Form 1098.
- Use line 17 for state and local general sales tax reduction.
Check the Settlement Statement
When you take out a home mortgage loan, you will be provided with a HUD-1 Settlement Statement. This document must be provided by the lender or broker to the borrower of a loan being used to purchase or refinance a house. You are allowed to request a HUD-1 Settlement Statement the day before the closing so that you can inspect it. The document itemizes everything that you are paying for. You’ll want to make sure you have a copy of this document for your tax records since a lot of the information contained in the document can be used to check the accuracy of your closing cost tax deductions.
Deduct Mortgage Points
Although you can deduct the mortgage points charged as the loan origination fee, you do need to meet a certain number of requirements to be able to do so. These requirements include the following:
- The loan is being used towards building or buying a primary residence.
- Mortgage points are standard practice in the area in which you took out the loan.
- You didn’t pay more points than what’s typically charged in the area in which you took out the loan.
- You’re deducting the points in the year that you paid for them.
- You didn’t pay for mortgage points that included items that are usually listed separately, such as title fees, inspection fees, appraisal fees, and attorney fees.
- The points were calculated as a percentage of the home’s purchase price.
- Your settlement statement specifically defines the loan origination fee as points.
When it comes to deducting your points, you have two options: you can deduct them in full for the tax year in which you paid them or you can deduct them over the life of the loan, beginning with the year in which you received the loan.
Deduct Property Taxes
You can deduct property taxes that you pay on any real estate that you own. If you paid the delinquent taxes of a seller as part of the sales agreement, you cannot deduct those on your tax return. The amount of property tax you can deduct is limited to $10,000 a year as of 2017.
Deduct Prepaid Interest
One option buyers have is to purchase points to reduce their interest rate. Each point costs 1 percent of the purchase price. By buying points at closing, you’re buying down your interest, which is why it’s called prepaid interest. The IRS considers these points the same as the loan origination points for practical purposes. As a result, you can deduct any points that you’ve purchased as prepaid interest.
Which Particular Closing Costs are Completely Non-Deductible?
While several of your closing costs are deductible (as previously discussed), there are many closing costs that you cannot write off. The following are the non-deductible closing costs you should be aware of:
- Pre-move-in utility charges – You cannot write off any pre-move-in utility charges when transferring or setting up the utility services in your new home.
- Fire and flood insurance or certificates – You may be required to purchase fire and flood insurance based on any inherent fire or flood risks revealed during the inspection. You can’t write this off.
- Pre-closing rent – If you moved into the house before you officially closed on it, you cannot deduct any rent that you pay to the owner leading up to the official purchase.
- Mortgage refinancing – If you’re refinancing your home, you will not be able to write off the majority of your refinancing costs or closing costs.
- Title fees – Although the seller will pay for the buyer’s title insurance policy, the buyer has to pay for the lender’s insurance policy. As the buyer, you will also have to pay for a title search, which identifies if there are any other parties that may have ownership claims in the house you’re buying. None of the title fees you pay are deductible.
- Real estate commissions – You cannot write off any commissions paid to your real estate agent. Generally speaking, the seller is responsible for paying your agent’s commission anyway.
- Costs of the appraisal – All lenders require an appraisal to ensure that the amount of the loan doesn’t exceed the value of the house. An appraisal costs around $300 to $400 and is non-deductible. The only exception is if the property you’re purchasing is a rental property, in which case you can deduct the appraisal fees.
- Home inspections – Home inspections are required to ensure that the house doesn’t require significant repairs that could hurt the value of the property. The buyer is responsible for paying for these inspections, which are non-deductible.
- Costs of reporting credit – It costs the lender around $30 to $40 to pull your credit report, which you will have to pay for and cannot write off.
- Transfer taxes – Many counties charge a transfer tax when the ownership of a property changes hands. Transfer taxes are non-deductible.
- Attorney fees – If you used an attorney to assist in your closing, you will be responsible for paying their fees. These fees vary based on their hourly rate and cannot be written of.
Understanding Your Tax Deductible Costs is Crucial to Saving Money
Buying a new house is expensive, especially when considering all of the closing costs that you will need to pay upfront (in addition to that substantial down payment you have to make). Knowing exactly what you can deduct when it comes time to file your taxes will help to offset some of those home-buying expenses.