When it comes to the upfront costs of buying a home, most people immediately think about the down payment. However, closing costs, which are fees associated with securing a mortgage and working with third parties, can be a significant part of the homebuying process. As you prepare for tax season, it’s natural to wonder if any of these closing costs can provide some relief on your federal income taxes.
While the answer isn’t as straightforward as you might hope, there are some important tax deductions available for homeowners that can ease your tax burden. Let’s take a closer look at which closing costs are deductible and how you can benefit come tax time.
What Closing Costs Can You Deduct?
Unfortunately, most of the fees involved in closing a mortgage aren’t deductible. However, there are two notable exceptions: mortgage points and property taxes paid in advance. Here’s how they work:
Property Taxes
Property taxes are always deductible, and if you pay any property taxes upfront as part of your closing costs, you can claim those at tax time. This typically happens when your lender sets up an escrow account for you. In this arrangement, you make monthly payments that cover your property taxes and homeowners insurance. When these bills are due, your lender pays them on your behalf using the funds in your escrow account. Any property taxes you’ve prepaid can be deducted from your taxes, helping to reduce your overall taxable income.
Mortgage Points
Mortgage points, also known as “discount points,” are another closing cost that is tax-deductible. When you purchase points, you’re essentially paying upfront to lower the interest rate on your mortgage. Each point costs 1% of your total loan amount. For example, if you refinance a mortgage for $200,000 and buy one point, you’ll pay $2,000 to lower your interest rate by 0.25%. These points can help you save money on interest over the life of the loan, and they also offer a tax advantage: the IRS allows you to deduct the full amount of the points you paid in the year you purchased them. However, this deduction is only applicable if the mortgage is for your primary residence.
What Closing Costs Are Not Tax-Deductible?
While mortgage points and property taxes are the exceptions, most other closing costs aren’t tax-deductible. Some of the most common non-deductible closing costs include:
- Abstract fees
- Legal fees (such as title searches and preparation of sales contracts)
- Recording fees
- Owner’s title insurance
- Credit check fees
Although these costs aren’t deductible, there is a potential tax benefit when you sell your home. You can add these fees to your home’s cost basis, which could reduce the amount of capital gains tax you owe when you sell the property. This can be especially useful when calculating any profits from your home sale, as you can offset some of the taxes by including closing costs and home improvement expenses in the cost basis of your property.
When Can You Deduct These Costs?
There is flexibility in when you can claim certain closing costs, depending on the nature of the expense.
In The Year of Closing
If you itemize your deductions, you can typically deduct mortgage points and property taxes in the year you close on your home. So, for example, if you close in 2024, you can deduct those costs when filing your 2024 taxes.
However, the deduction for mortgage points may be a bit more complicated. The IRS has specific rules to ensure these points are a legitimate business practice in your area, and you must meet certain conditions for the deduction to apply. These include:
- The mortgage must be for your primary residence
- Points must be a standard practice in your area
- Payments for points must be properly documented
Over the Lifetime of the Mortgage
Alternatively, you can spread out the deduction for mortgage points over the life of your mortgage. This might make sense if you’re not itemizing in a given year, allowing you to claim the deduction when it’s most beneficial to you. In addition, if you refinance your mortgage, the same rules apply to the deductible costs like mortgage points and property taxes.
What About Cash-Out Refinances?
If you’re doing a cash-out refinance, where you refinance for more than you owe on your current mortgage and take the difference as a lump sum, there could be another potential tax benefit. Specifically, you could use the proceeds from the cash-out refinance to make capital improvements to your home, which may allow you to adjust the cost basis of your home and potentially reduce any capital gains tax you owe when you sell. However, this is only the case if you use the cash-out funds to improve the value of the home, not for other purposes like paying off debt or taking vacations.
FAQs About Closing Cost Deductions
Are private mortgage insurance (PMI) or mortgage insurance premiums (MIP) tax-deductible?
It depends on the tax year. While mortgage insurance premiums were deductible in past years, Congress has adjusted this benefit in recent years. For 2024, you cannot deduct PMI or MIP.
Can I deduct closing costs on my taxes?
The IRS allows for deductions on specific closing costs, such as mortgage points and property taxes paid upfront.
How much property tax can I deduct?
The Tax Cuts and Jobs Act of 2017 placed a cap of $10,000 on the total amount of state and local taxes (including property taxes) that can be deducted. This applies to both single and married taxpayers.
How much mortgage interest can I deduct?
You can deduct mortgage interest payments on up to $1 million in debt if you purchased your home before December 15, 2017. For homes bought after that date, the limit is $750,000 in mortgage debt.
Final Thoughts: Making the Most of Your Closing Costs
Although many closing costs aren’t deductible, there are still tax benefits available to homeowners. Understanding which costs are eligible for deduction—like mortgage points and property taxes—can help you maximize your tax savings. As a homeowner, it’s important to stay informed about your tax responsibilities and opportunities to reduce your tax burden. If you’re uncertain about your eligibility or how to claim these deductions, it may be helpful to consult with a tax advisor for guidance tailored to your situation.
At AvantiWay Financial, we’re here to help you navigate the complexities of homeownership and finance. Whether you’re purchasing a home or refinancing, we can assist you in understanding your financial options and tax benefits along the way.
