Any mortgage process will include fees, particularly closing fees. As tax season begins, it’s good to know if any closing costs tax deductions are available that can save you money.
One of the most frequent questions homeowners and refinancers ask is: “Are closing costs eligible for deduction on my federal income taxes?”
For the most part, the answer is “no.”
But, like many aspects of our tax code—there are exceptions.
Skip ahead: Get started with AAA Banking.
What are closing costs?
Before any homebuyer starts the buying process, they should consider closing costs as part of their budgeting plan.
These fees are how most mortgage lenders receive their income or profits—generally equaling 3-6% of the loan amount.
For instance, on a $200,000 loan, closing costs could be between $6,000 and $12,000.
Homebuyers should receive a closing disclosure at least three business days before closing that enumerates all these fees and costs.
How do tax deductions work?
Taxpayers can include certain items to lessen their taxable income when filing a federal tax return. This option will ideally result in lower taxes paid for the year.
People can decide to either calculate their own deductions by itemizing their deductions or opt for the standard deduction and not itemize.
For 2022, single taxpayers and married individuals filing separately can claim a standard deduction of $12,550, while couples filing jointly can take a deduction of $25,100 as per the 2017 Tax Cuts and Jobs Act.
Homeowners, in particular, can take advantage of two of the more beneficial deductions.
Those who purchased a residence before or after Dec 16, 2017, can deduct the interest paid on their mortgage up to $1 million.
Property taxes can also be deducted, with a cap of $10,000.
Check your mortgage optionsTax-deductible closing costs: What are they?
Unfortunately, most tax deductions do not apply to closing costs.
However, points purchased to lower the interest rate on your loan, as well as property taxes paid in advance, are exceptions.
Escrow
When a mortgage loan is taken out, property taxes are typically deductible.
In addition, most lenders will establish an escrow account for the borrower and require them to pay some of the taxes upfront prior to the due date.
When you have an escrow arrangement, your mortgage payment will include extra money for the annual property taxes and homeowners insurance.
Your lender accesses these funds when the insurance and tax bills are due to take care of the payments. At tax time, you’re eligible to deduct any property taxes that have already been paid.
Mortgage points
Homebuyers can deduct mortgage points from their taxes.
These points are used to reduce the interest rate on the loan. Each point is 1% of the total loan and usually reduces the rate by 0.25%.
For example, on a mortgage of $200,000, a point would cost $2,000 and lower the rate from 5% to 4.75% for the entire loan term.
The big advantage of paying points on a loan is reduced interest costs over the loan’s lifetime.
In addition, it is also possible to deduct the full amount of points when filing taxes. This deduction applies to mortgages used to purchase or construct a primary residence.
Which expenses cannot be claimed as a deduction for closing costs?
Generally, only costs related to mortgage interest, points purchased, or property taxes can be claimed on taxes. Other closing costs, such as the following, are not eligible for deduction.
- Abstract fees
- Recording fees
- Credit check fees
- Owner’s title insurance
- Legal fees (including preparation of contracts, deeds, and title search fees)
One tax advantage to these fees is adding them to the cost basis of your home when it comes time to sell. Adding these fees lowers the amount of your profit on your return, which can reduce any capital gains tax you might have to pay.
Contact a AAA Banking loan officer today.
When can you use closing cost deductions?
Homeowners can select the time to declare their tax-deductible closing costs.
The year the sale closed
Itemizing your deductions allows for the deduction of closing costs for the year in which the home was purchased. This option means that if you closed on your home in 2021, those costs could be deducted from your 2021 taxes.
If you buy mortgage points, however, things get a little tricky. The IRS has certain criteria that need to be met to deduct the cost in the tax year of purchase, which includes the following:
- The points were used to purchase (or build) the borrower’s primary residence
- There has to be an established practice of using points in the local real estate market, and the price paid for points is along that area’s average
- The purchasers or sellers must pay for these points, and the payments must be documented
- Borrowers can’t borrow funds to pay for points
- The amount paid must be explicitly stated and itemized on the loan’s closing disclosure or settlement statement
Over the loan term
Closing costs deductions might also be spread throughout the mortgage, but only during those years where you itemize your deductions.
There could be the occasional year in your future where using the standard deduction may make more sense than itemizing.
In these cases, you can wait and claim the points deduction in years when you itemize.
Can you deduct refinance closing costs on taxes?
Refinancing your primary mortgage enables many to save on taxes and lower their interest rate.
The same type of closing costs—paying property taxes in advance and buying down the interest rate—can also be claimed on your itemized federal income taxes.
If you’re choosing a cash-out refinance, you’ll likely refinance for an amount that is higher than your current mortgage balance and receive the difference as a cash payout.
This payout could be utilized to lower the cost basis of your home, thus reducing capital gains tax when the time comes to sell.
For this to be possible, however, the money must be used to make capital improvements on your home. It’s recommended to talk to a tax advisor for more clarification.
Apply for a low-rate mortgage or refinancing
Whether you want to purchase a home or refinance your current home, AAA Banking is here to help.
We make the mortgage process easier than ever to get you the right home or the best rate for refinancing. Our professional loan officers are here to answer your questions about any aspect of the mortgage process.
Our partnership with the HomeScout home search program helps homebuyers everywhere find their dream home.
Get started with AAA Banking today.
Consult your tax advisor for further information regarding the deductibility of interest and charges.
Photo by Nataliya Vaitkevich