Are Closing Costs Tax Deductible

Purchasing a home is one of the biggest financial decisions you’ll ever make. Sneaky closing costs, such as property taxes and insurance premiums, can make that decision even more costly and run up thousands of dollars in extra fees and expenses.

At tax time, however, some of these closing costs can bring you some relief through tax deductions meant for homeowners with mortgages. We’ll go over which closing costs are tax deductible when buying a home, which isn’t, and when you can claim your deductions. 

Key takeaways

• Closing costs such as mortgage interest, property taxes, and mortgage points can be eligible for tax deductions.
• Most closing costs aren’t tax deductible, but you can include them in your cost basis to save on capital gains when selling a home later on.
• You can claim tax deductions for closing costs during the year you paid or throughout the lifetime of your mortgage.

Table of Contents

• What are Closing Costs?
• What Closing Costs Are Tax Deductible?
• What Closing Costs Are Not Tax-Deductible?
• When Are Closing Costs Tax-Deductible?
• Simplify Your Tax Workflow With FreshBooks
• Frequently Asked Questions

What are Closing Costs?

When you buy a house, a down payment isn’t the only thing you’ll need to bring to close the deal. Closing costs are expenses beyond your down payment and mortgage loan, such as attorney fees, appraisal fees, origination fees, discount points, and a range of other costs.

Closing costs typically represent between 2% and 5% of your overall mortgage amount, but specific costs depend on the type of loan you take and where you live. That means that if your mortgage is $500,000, you can expect to pay closing costs between $10,000 and $25,000.

Many first-time home buyers don’t know they can reduce closing cost expenses with tax deductions. There aren’t many closing costs that are tax deductible, but those that are can add up to significant savings.

What Closing Costs Are Tax Deductible? 

Here are some expenses you may encounter when buying a house. Let’s take a closer look at them and how they can benefit you during tax season.

You must itemize your deductions on Schedule A (Form 1040) in order to claim the deductions below.

Property Taxes

Local and state real estate taxes, otherwise called property taxes, are always deductible within the same year they’re paid. You can also usually deduct any portion of property taxes paid at closing in escrow arrangements.

Keep in mind that the IRS caps the amount you can deduct in a given year. Married couples filing jointly and individuals can deduct up to $10,000 per year in a combined total deduction of state and local income, sales, and property taxes. Married couples filing separately can deduct up to $5,000 per year. The 2017 Tax Cuts and Jobs Act, which enacted this provision, is set to expire on December 31, 2025, but the outcome of the 2024 presidential election may see this deadline extended.

Mortgage Interest

The IRS allows you to deduct home mortgage interest each year in which you own your home, subject to limitations. This deduction, known as the “mortgage interest deduction,” enables individuals and married couples filing jointly to deduct interest on the first $750,000 of a mortgage taken out on or after December 16, 2017, or $375,000 per person if married and filing separately. If your home acquisition debt was incurred before December 16, 2017, the limits increase to $1 million for individuals and couples filing jointly or $500,000 if married and filing separately.

Mortgage Points

Home buyers sometimes purchase mortgage points or discount points, which each represent 1% of their total loan amount, to save on mortgage interest. These charges, sometimes called loan origination fees, are considered prepaid interest because they reduce interest expenses throughout the lifetime of the loan. 

Since the IRS designates mortgage points as prepaid interest, you generally can’t deduct the full amount of points in the year paid. Instead, you can deduct them over the term of the mortgage loan. In order to fully deduct the points in the year paid, you must meet 9 different criteria, such as your main home securing the mortgage loan. If you don’t meet all of these eligibility criteria, you can claim these deductions over your loan’s life rather than in the year you paid for the points.

Mortgage Insurance Premiums

Per the IRS, prior to 2022, 4 types of expenses qualified as mortgage insurance premiums: private mortgage insurance, VA funding fees, FHA (Federal Housing Administration) loan up-front mortgage premiums, and USDA loan guarantee fees. These expenses could be paid either monthly, in a lump sum financed with your mortgage, or in a lump sum at closing.

Whether paid at closing or financed, the IRS allowed you to deduct lump sum mortgage insurance premium fees in the year you closed your mortgage. Like other tax-deductible costs, the IRS limits how much you can deduct for mortgage insurance premiums based on your gross combined or separate income. 

Note: The itemized deduction for mortgage insurance premiums (PMI) has expired. You can no longer claim the deduction as of tax year 2022.

Distressed Property Costs

Purchasing a distressed property, where a seller urgently sells their asset and often below market value, generally comes with added costs on the buyer’s end for repairs and overdue maintenance. If you have buyer costs related to distressed property repairs or maintenance, they could be tax deductible. Capital improvements increase the value and adjusted basis of your home and can help lower the capital gains tax when selling the property at a profit.

Nobody looks forward to tax preparation, but it doesn’t have to be a totally unpleasant experience. 

What Closing Costs Are Not Tax-Deductible?

Generally speaking, the only closing costs that qualify for tax deductions are those related to your mortgage, property taxes, and buying points. Most legal and housing-related costs aren’t tax deductible, including:

• Abstract Fees
• Home Inspections
• Appraisal Fees
• Document Prep
• Utility Payments
• General Maintenance And Repair
• Homeowners Insurance Premiums
• Title Insurance
• Transfer Taxes
• Surveys
• Recording Fees

Although these costs aren’t tax deductible, you can still sometimes use them to reduce your overall tax bill. By adding these fees to the cost basis of your property when you sell, you reduce your profit and therefore the amount of capital gains tax you owe following the sale. 

When Are Closing Costs Tax-Deductible?

You can claim your closing cost tax deductions in the year you pay them, over the lifetime of your mortgage loan, or when you sell your home.

If you itemize your taxes, you can usually claim closing costs in the year in which you paid them and closed on your home. You can also claim tax deductions on points paid within the given year.

Are home improvements tax deductible? If you take out a new home loan for home improvements and renovations or purchase mortgage points, they may be eligible for tax deductions. Remember that you’ll have to meet the following 9 IRS conditions for your points to be tax deductible:

1. Your main home secures your loan.
2. Paying points is an established business practice in the area where the loan was made.
3. The points paid were priced according to the area’s standard.
4. You use the cash method of accounting.
5. The points paid weren’t for items that are usually listed separately on the settlement sheet such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
6. The funds you provided at or before closing, including any points the seller paid, were at least as much as the points charged.
7. You use your loan to buy or build your main home.
8. The points were computed as a percentage of the principal mortgage amount.
9. The amount shows clearly as points on your settlement statement.

Alternatively, you can spread your closing costs for mortgage points over the lifetime of your loan. As long as you still hold the mortgage, a portion of your mortgage points paid can still be eligible for tax deduction. Likewise, you can deduct any additional points paid on a refinance loan where you only used a portion of the funds.

Simplify Your Tax Workflow with FreshBooks

Whether you’re a first-time homebuyer or you’re thinking about your next investment property, understanding your closing costs and which are tax deductible can help you boost your savings throughout your home ownership. 

For managing your savings, expenses, and other aspects of your finances, check out FreshBooks accounting software. Besides helping you find every closing cost tax deduction opportunity, it can help you track and categorize both your personal and small business finances. If you’re eager to get your finances in order, try FreshBooks free and start today.

FAQs About When Closing Costs are Tax Deductible

Between closing costs, tax deductions, mortgages, and more, your finances can get pretty confusing. That’s why we’ve answered the top questions about tax-deductible closing costs.

How does buying a house affect your tax return?

Buying a house means you can access a number of tax deductions and benefits that help make your purchase and home ownership more affordable, such as tax deductions for mortgage interest, mortgage points, property taxes, and more. FreshBooks expense tracking software can help you itemize your expenses and find every tax deduction.

Are closing costs capitalized or expensed?

The IRS has a number of closing costs designated as capitalizable, which are added to the cost basis and typically include expenses such as title fees, legal fees, transfer taxes, assignment fees, surveys, and recording fees.

Are refinance closing costs tax deductible?

When you refinance your mortgage to get a lower interest rate or better loan terms, you can generally take advantage of the same tax deductions, such as for mortgage interest and mortgage points paid, as when you take out a new loan.

Are there limits to the amount of closing costs I can deduct?

You can’t deduct more than $10,000 per year or $5,000 if married filing separately for combined property taxes, sales, state, and local income taxes. For mortgage loans, you can only deduct interest paid on the first $750,000 of mortgage debt or $375,000 if married and filing separately. 

Do I need to itemize deductions to claim mortgage closing costs?

Most taxpayers opt to claim standard deductions, but you’ll have to itemize your closing costs to claim mortgage interest, points, and real estate tax deductions.

Does having a mortgage help with taxes?

Having a mortgage can help with eligibility for certain tax deductions. Depending on the loan, mortgage holders can typically claim tax deductions for mortgage interest as well as any eligible mortgage points paid.

More Useful Resources

• How to Close the Books
• Requirements for Tax Exemption
• How Much Do You Have to Make to File Taxes?
• Are Funeral Expenses Tax Deductible?
• Mileage Tax Deduction Rules
• Sales Tax Deduction
• Are Home Improvements Tax Deductible?
• SALT Tax Deduction
• Mortgage Interest Deduction
• QBI Tax Deduction
• Educator Expense Tax Deduction

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