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Home closing costs make up a large portion of home-buying expenses, second to the down payment. Homeowners can benefit from tax deductions for three main costs: points and mortgage interest, when a home is financed, and real estate taxes. The costs can only be deducted for the tax year in which they were paid.
To deduct closing costs, you must use the itemization method of deductions. You list deductible items on Schedule A of IRS Form 1040. It makes sense for taxpayers to itemize when their deductible expenses exceed the standard deduction for the year. According to the Los Angeles Times, most taxpayers take the standard deduction and those who itemize typically have higher incomes. As such, high-income earners generally have higher-cost homes with higher closing costs, which can result in big savings at tax time.
Closing costs, also known as settlement fees, must be disclosed to the buyer and seller at closing on the Department of Housing and Urban Development's HUD-1 statement. A homeowner can refer to his HUD-1 form when preparing his taxes for optimal accuracy. Although the lender and tax authority may send statements of mortgage interest and taxes paid for the year, they may not include amounts paid at closing. Property taxes can be found in Section 100; points in Section 800; and mortgage interest in Section 900 of the HUD-1.
Closing costs cover loan expenses, third-party service fees, such as escrow and title, as well as administrative fees, such as notary and courier. Loan expenses include points, which represent a percentage of the loan amount. Points include origination fees from the lender or mortgage broker and amounts paid to manipulate the loan's interest rate. Known as a discount point, this lump sum lowers the buyer's rate, and a premium increases the rate in exchange for lender-paid closing costs. The HUD-1 reflects mortgage interest paid through the end of the month in which the transaction closes. It also shows the portion of taxes the buyer must pay from the day he takes ownership through the end of the fiscal year.
Homeowners can even deduct closing costs they did not actually pay out-of-pocket. For example, a buyer and seller can negotiate a seller credit to cover a portion, or all, of the buyer's closing costs as an incentive to purchase. The seller is debited a lump sum at closing, which is applied to the buyer's closing costs. The seller can pay for loan costs, the buyer's portion of services, miscellaneous fees, prepaid and prorated items.
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