Can You Deduct Closing Costs on Your Taxes?December 07, 2017
When you buy a home, the negotiated sales price is not the only cost you will have to pay. You need are also responsible for paying closing costs. Home closing costs, also referred to as settlement charges or settlement fees, aren't cheap. Closing costs are around three percent of the home's sales price. However, closing cost deduction can provide a tax benefit.
In most situations, home buyers can deduct most, if not all, of their home closings costs from their taxes in the year they make their purchase. The tax-deductible closing costs include origination fees or points, prepaid interest, and property taxes. Again, not all closing costs are deductible. Non-deductible costs include:
• Legal fees
• Credit report costs
• Home inspection fees
• Appraisal costs
• Title fees
• Transfer taxes for a primary residence
• Real estate commissions
You need to understand that settlement fees are only deducted if you itemize the deduction on IRS Form 1040. You will not be able to get any benefits of a closing cost deduction if you file a 1040EZ. Form 1040 allows you to claim itemized deductions or the standard deduction. Home closing costs are an example of an itemized deduction.
Whether a real estate agent is used or an independent mortgage broker, the type of loan, and type of property purchased can affect home closing costs. The HUD-1 Settlement Statement is a form that is used in almost every real estate transaction. The HUD-1 records every closing cost that gets paid by the borrower and the seller. You need to have a copy of this statement in your tax records.
It isn't uncommon for a mortgage loan to include a settlement charge for points. Points are also referred to prepaid mortgage interest. Prepaid mortgage interest is interest paid on a mortgage before it is due. Some borrowers choose to pay points as a part of their closing fees as a way to reduce their interest payments. In some situations, paying points is a requirement set by the lender in exchange for approving the mortgage. The HUD-1 form may refer to points by the following names: loan discount, loan origination fee, or discount points.
Only in rare circumstances are you not able to deduct the full amount of the points in the year your house closes. If the period you prepay the mortgage interest for extends past the current year, the interest must be deducted over the years where the deductions apply.
Property taxes are another common settlement charge. The taxes get assessed and get collected by the county tax authority each year. When you acquire the new property, you are responsible for the property taxes. Because property taxes are paid annually, chances are the previous owner paid for your portion of the property taxes starting at the date of closing until the next tax billing cycle. To make up the difference, the HUD-1 Settlement Statement will reflect the property tax prepayment or tax payment. Those taxes are deductible on your 1040 tax return.
Prepaid interest and points may seem like they are the same thing, but they aren't. These two deductions are listed separately on most HUD-1 Settlement Statements. Points refer to prepaid interest over the lifetime of the loan. Prepaid interest refers to first partial month's loan interest. The majority of lenders require the mortgage to be paid on the first of the month. If your closing was on some day other than the 1st of the month, you will prepay interest for the remaining days of the month. This interest is also deductible if you file using a form 1040 tax return.
Closing costs are deductible. Taking advantage of this tax deduction is a great way to recoup some of the costs associated with buying a home. However, only if they are itemized. You need to find out if the itemized deductions are more than the standard deductions for that year. If they are not, then deducting closing costs will not make the most financial sense. Consult your tax professional or accountant to make sure all of the deductions you want to take make financial sense. You also need to make sure that the deductions are allowed by the IRS.
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