It’s closing day and you’re sitting in a conference room with a closing attorney who hands you document after document to sign. You’re nervous and excited. It’s a struggle to focus on what exactly you’re signing.
But somewhere in that pile of papers is a closing disclosure. This five-page form lists things like your interest rate and term, as well as a list of closing costs—things like taxes, interest, appraisal fees and title insurance. All those line items add up, and most home buyers pay around 2–5% of the purchase price in closing costs.1
You might be wondering, Are closing costs tax-deductible? Well, some are, but most aren’t. Let’s take a look at what closing costs qualify for a tax deduction.
What Closing Costs Can I Deduct on My Taxes?
Before you can even think about deducting closing costs from your income taxes, you have to meet one big qualification: The home must be your primary residence. And no, that vacation house you’ve had your eye on is not a primary residence.
Taxes shouldn’t be this complicated. Connect with a RamseyTrusted tax advisor.
And one more thing—and this is a big one—in order to deduct any closing costs you’ll have to itemize deductions instead of taking the standard deduction. And the vast majority (87%) of Americans take the standard deduction because it saves them the most money on their taxes.2
All that said, here are closing costs that usually are tax-deductible:
- State and local property taxes
- Prepaid interest
- Origination fees or points
- Private mortgage insurance (PMI)
State and Local Property Taxes
You can’t ever get away from taxes, and the tax man will take his cut at your closing too. Depending on where you live, you’ll usually have to pay some state or local property taxes. This could be a portion of the current year’s taxes or the full amount (if the due date is close).
Whether you’re closing on a house this year or not, you can always deduct property taxes. However, the State and Local Tax Deduction (also known as SALT) is limited to $10,000 per year for single filers and married couples.3
When you close on a house, there’s usually a gap of a month or so between when you close and when your first house payment is due. But that month isn’t interest-free! You’ll have to pay what’s called prepaid interest.
This interest is tax-deductible, and so is the rest of the mortgage interest you pay throughout the year. The mortgage interest deduction is usually a big one for homeowners who itemize. You can deduct the interest you paid on up to $750,000 of mortgage debt.4
Origination Fees or Points
Origination fees are charges paid by the buyer (or sometimes the seller) when they get a loan.5 These fees are usually 0.5% to 1% of the value of the loan. The IRS considers origination fees prepaid interest, so they’re tax-deductible in the year of the loan.
But wait. The IRS has some regulations, and here are the big ones:
- Your loan must be to buy or build your main home.
- You can’t borrow the money to pay for the points.
- The points must be figured as a percentage of your mortgage.
- The amount you paid for points must be clearly itemized on your loan’s closing disclosure or settlement statement.6
If you don’t meet those qualifications, you can still deduct your points over the life of your loan.
When you buy a home, you might have the option of paying for what’s called discount points to lower your interest rate. This is commonly called paying points. You’ll usually have to pay 1% of the value of the loan to lower your rate by a quarter of a percent. Discount points are tax-deductible as prepaid interest.
Paying points sounds like a good way to lower your interest rate, but it’s often a rip-off. It’ll take you about six years to recoup what you saved on interest by paying points, and most people have sold, refinanced or paid off their home by then. Instead of buying mortgage points, put that extra money toward your down payment and reduce your loan amount altogether!
Private Mortgage Insurance (PMI)
If you make a down payment less than 20%, you’ll be required to get private mortgage insurance. PMI protects your lender in case you default on your loan.
You have the option to pay PMI as a lump sum (that you pay in full at closing or tie into your loan) or to pay it monthly as part of your house payment.
PMI was tax-deductible for the 2021 tax year.7 But it currently isn’t deductible for 2022. Though it’s possible Congress might vote to extend the deduction later this year.
But seriously, even if you get a tax deduction, PMI is a bum deal. Do your best to save 20% for a down payment, so you don’t have to toss money out the window each month for PMI.
What Closing Costs Are Not Tax-Deductible?
Okay, back to that pile of paperwork you signed at your closing. You’ll see a bunch of closing costs that aren’t tax-deductible. Here are some common ones:
- Homeowners insurance premiums
- Inspections (home, pest, flood)
- Appraisal fees
- Title insurance
- Escrow fees
- Homeowners association (HOA) dues
- Miscellaneous fees (notary, title fees, document prep, attorney fees, credit reporting)
Are Down Payments Tax-Deductible?
If you’re like most home buyers, your down payment will be the largest line item on your closing statement—especially if you’re putting at least 20% down. But nope, a down payment is not tax-deductible.
Are Seller Closing Costs Tax Deductible?
When it comes to seller closing costs, the giant one is real estate agent commissions. They usually total about 6% of a home’s sales price.8 But you’re out of luck if you want to deduct commissions from your income taxes. However, keep in mind that if you’ve lived in a home for at least two years, you only have to pay taxes on the profit from the sale of your home if you made more than $250,000 for a single filer or $500,000 for a married filer.9
Now, if you’ve lived in a home for less than two years, you’ll owe capital gains taxes. When calculating your profit to figure out how much you owe, you can add closing costs to the overall cost of your home. So this is kind of like a deduction that will lower the profit you owe capital gains taxes on.
Are Closing Costs for a Rental Home Deductible?
Taxes can get pretty complicated when you decide to become a landlord. Honestly, life in general can get complicated when you decide to rent out a house—but that’s a different story.
If you have a rental house, that means you’ll have rental income. Just like with your primary residence, you can deduct things from your rental income like mortgage interest, PMI and taxes.
But wait—if you can deduct mortgage interest, that means you borrowed money to buy a rental. If you’re not in the position to pay cash for a rental, don’t buy it. It’s that simple. Don’t count on rent from tenants to cover the mortgage. Wait until you have the money to afford the entire house on your own, then buy the house.
If you purchased a rental home with cash, you can add any closing costs not related to a home loan to the cost basis of the home.10 So, if you bought a home for $100,000 and paid $3,000 in closing costs, your total cost of the home is $103,000. This is important because a rental home can be depreciated as an asset, which means you can take small deductions based on the cost of the home over 27.5 years.11
Are Closing Costs for a Mortgage Refinance Deductible?
If you refinance your home to get a lower interest rate, the IRS only allows you to deduct origination fees over the life of the loan. You can’t deduct them as a lump sum.12
The deductions for taxes, mortgage interest and PMI remain the same whether you’re refinancing or buying a new house.
Find a Tax Pro in Your Area
Hey, taxes can get pretty complicated when it comes to real estate. Need help? Our Endorsed Local Providers (ELPs) can guide you through the maze of tax paperwork and help you file your taxes with confidence. That’s why they’re RamseyTrusted.