Are Closing Costs Deductible? Homeowner Tax Questions Answered

Around early springtime each year, people file their taxes with the IRS. Among making sure that their income is reported accurately, people also look for expenses that they can deduct from their taxes to either save some money or get a larger refund. If you’ve purchased a home recently, you’ll already benefit from a few excellent tax breaks and advantages. But you might wonder whether your closing costs – the collection of fees and extra charges that are tacked onto the end of any property purchase – are tax-deductible as well. Let’s break down whether closing costs are tax-deductible, which costs you should focus on, and whether itemizing your deduction is a wise idea.

What Does It Mean for Something To Be “Tax-Deductible?”

In a nutshell, an expense is “tax-deductible” if the IRS (Internal Revenue Service) allows you to subtract that expense from your total income when you calculate your taxes at the end of the year. People look for tax-deductible items (expenses) since it effectively lowers their yearly income, and how much tax they ultimately owe the IRS.  As taxes are based on your overall income, lowering your income by even a small amount can result in you paying fewer taxes for that year. The majority of homeowners already enjoy two tax benefits when they buy a home: they get to deduct their mortgage’s interest and they get to deduct their property taxes. However, many people wonder whether closing costs are also tax-deductible items , especially since there are many of them.

What Are Closing Costs?

Closing costs are specific expenses that you pay when you "close" a deal on your home or any other property you have just purchased. Closing costs extend beyond the initial down payment or primary purchase and include any ancillary fees that are outlined in your purchase agreement or title. In general, closing costs run between 3 to 5% of the total loan amount.  They can include a wide variety of fees, such as:

• Appraisal and survey fees – These help confirm the fair market value for your property or home. These usually total several hundred dollars at a minimum.
• Loan origination fees – These fees are included when processing and underwriting your home’s home. Obviously, these will not be present if you pay for a home without taking out a loan. Fee amounts can vary significantly, from as low as $50 up to several hundred dollars.
• Homeowners insurance – This insurance is required for most home purchases. The first year of insurance, which can be anywhere from a few hundred to a few thousand dollars depending on the value of the property, is usually paid when you close the deal. 
• Title insurance – This insurance protects both the buyer and the lender, and the price is calculated based on the total purchase price of the property. 
• Mortgage points – These can also be called discount points. They are paid straight to the lender during the closing of a deal so you can get a lower interest rate on your mortgage. 
• PMI, or private mortgage insurance – If you close on a home and your down payment is less than 20%, you might be required to pay PMI. This protects the lender against losses.
• Property taxes – These are usually up to six months of advanced taxes that you're required to pay at closing. The amount can vary from location to location.
• Attorney fees – Some states require you to have an attorney present at closing, and their fees might be included as part of your closing costs.
• Closing or escrow fees – These are fees that go to the escrow agent that helps your deal to officially close, and amounts can vary significantly.
• And other miscellaneous fees – Examples include the cost to register your home purchase with your local government or the cost for a credit check.

As you can see, closing costs can quickly add up to quite a big chunk of change. This is why many people seek to deduct them from their taxes at the end of every tax year. Fortunately, all closing costs are usually broken down with your purchase agreement, so you can easily refer back to that document when filing your taxes and deducting them.

Are Closing Costs Tax Deductible?

This answer is, unfortunately, not quite simple. According to the IRS, only some closing costs are tax-deductible while others must still be counted as part of the regular income you report at the end of the tax year.

Eligible Closing Costs

The IRS has a list of which closing costs are tax-deductible, which is re-created below.  Ultimately, only a handful of closing costs are tax-deductible due to a variety of legal and financial reasons:

• The sales tax issued at closing . This can still add up to quite a big amount if your home is worth hundreds of thousands of dollars.
• The real estate taxes that were charged to you when you closed.
• Any real estate taxes paid for by your mortgage lender and that may have been passed onto you as closing costs.
• Mortgage interest that was paid when the cost was settled. This can add up to many thousands of dollars depending on the value of your home.
• The interest you paid at closing . Many homeowners will want to note this item in particular as it can add up to hundreds or even thousands of dollars.
• Any loan origination fees . These can be written off as a percentage of your borrowed loan amount. These usually come out to about 1% of the total cost of your mortgage on average.

The last item is particularly notable. The IRS only lets you deduct those fees if your loan is for your primary place of residence. Thus, you can’t deduct loan origination fees if you purchased a property to rent to someone else or took out the loan for your business .

Non-Deductible Closing Costs

Unfortunately, there are many more closing costs that are non-deductible than there are deductible closing costs. These include:

• Any utility charges that were charged to you before you moved in
• Flood and fire insurance costs
• Pre-closing rent
• Costs for appraisal
• Home inspection fees
• Title fees
• Mortgage refinancing costs
• Real estate commission costs and fees
• Transfer fees
• Attorney fees
• Credit report costs

Ultimately, each of the above items is added to the total cost of your property. You should still note these on your IRS tax Form 1040 as separate costs if you wish to try to deduct some of them.

How to Deduct Your Closing Costs

The majority of American taxpayers take the Standard Deduction , which is a catchall deduction that assumes a certain number of deductible expenses in exchange for convenience. People take the Standard Deduction when they don’t want to calculate all the various expenses that may qualify as deductions and instead just get a minor tax break. However, you cannot take the standard deduction if you want to deduct your closing costs. This means you’ll need to go through your yearly income and expenses carefully to find all potential deductible items so you get your maximum refund (or are taxed as little as possible). If you want to deduct your closing costs, you’ll need to fill out your 1040 Form and come up with a list of itemized deductions. Use the list above or the IRS website when creating your list. Note that this will take a little bit of forethought and planning, so it’s not for folks who hate doing taxes! 

Should You Take the Standard Deduction?

It depends. Many people prefer to take the standard deduction since it’s easier to calculate and they don’t have to dig through the rest of their purchase receipts or bank account history. In general, it’s probably a better idea to take the standard deduction if your home isn’t a (relatively) expensive piece of property or your closing costs weren’t exorbitant. You’ll often save more money this way than by gaining a lot of little savings through itemizing all of your deductions, one by one. However, you can always ask a tax company to take a look at your accounts and make the decision for you. This may be easier than analyzing the situation yourself.

Summary

All in all, some closing costs are tax-deductible and, depending on the cost of your property purchase, could end up saving you thousands of dollars. However, some homeowners may decide to stick with the standard deduction instead of deducting their closing costs item by item. It’s ultimately up to you. Whatever you decide, be sure to look at the closing costs for your home carefully and never approach any home deal without ensuring your other debts are controlled .  Contact Seek Capital today for more information about personal loans and financial wellness!  Sources https://www.irs.gov/publications/p530 https://www.irs.gov/credits-deductions-for-individuals https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2020