When you purchase your home or buy land for your new home from a seller, you're responsible for paying closing costs on top of the negotiated contract price. These costs are sometimes shared by the seller depending on how you negotiate the deal. As you sign the dotted line, you might wonder, "Are closing costs tax deductible?" The IRS has some specific rules on itemized deductions for homeowners regarding deducting real estate closing costs. Here's what you need to know.
CAN YOU DEDUCT CLOSING COSTS ON YOUR TAXES?
Homeowner tax deductions aren't always easy to calculate, but the IRS does break down what types of tax deductions you can take when you file Form 1040. The only way to deduct closing costs, such as property tax, is by using itemized deductions. You cannot take a standard deduction and also deduct your closing costs, so you have to decide which one offers the most tax advantages for your situation.
DEDUCTIBLE CLOSING COSTS
If you decide to itemize, you'll need to know what closing costs you can actually deduct. The IRS identifies them as:
_Home mortgage interest paid at settlement that is found on the mortgage interest statement provided by the lender
_Certain real estate taxes paid at closing
_Real estate taxes _ listed on your real estate tax bill _ the lender paid from escrow to the taxing authority
_Sales taxes paid at closing
_Points _ also known as loan origination fees, maximum loan charges, loan discounts or discount points _ which are a one-time closing cost that provide you a discounted rate on your mortgage and can be deducted only over the life of the mortgage
_Mortgage insurance premiums, except for mortgage insurance provided by the Department of Veterans Affairs or Rural Housing Service
ABOUT DEDUCTING POINTS
Some situations that enable you to deduct the full amount of points in the year if you pass several tests set forth by the IRS. If you meet the following criteria, you have the option of deducting the full amount of points in the year you take out the mortgage or deducting them over the life of the loan, beginning with the year you close your loan:
_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
_Points were not paid in lieu of paying other fees, such as appraisal fees, inspection fees, title order fees, attorney fees and property tax fees
_The money you paid at or before closing, plus any points the seller paid, were at least the equivalent of the points charged
_You're using your loan to buy or build your main residence
_The points were calculated as a percentage of the mortgage's principal amount
_The points charged are clearly shown on the Uniform Settlement Statement, Form HUD-1
NON-DEDUCTIBLE CLOSING COSTS
There are several settlement costs and closing costs you can't deduct or add to the basis of your home. The following closing costs are not tax-deductible:
_Fire insurance premiums
_Charges for using utilities or services if you occupied the home before closing
_Rent paid if you moved into the home before closing
_Charges associated with getting or refinancing a mortgage loan, such as credit-report ordering costs, loan assumption fees and fees for a lender-ordered appraisal
Although you're permitted to deduct some types of real estate taxes, you can't 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
If you're eligible to deduct certain types of expenses related to home settlement fees, you can do so on Form 1040 on lines six through 13 when you file your tax return. Here's the breakdown of where to report different closing costs on the form:
_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 1
_Points not reported on Form 1098: Line 12
_Qualified mortgage insurance premiums: Line 1
_State and local general sales tax reduction: Line 7
KNOW ABOUT DEDUCTIBLE CLOSING COSTS
Some of your closing costs are tax-deductible, so it pays to know what expenses you can deduct as itemized homeowner tax 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're reporting all of your real estate taxes accurately and deducting only expenses that have the IRS seal of approval.
