Are Closing Costs Tax-Deductible?

Taking out a mortgage loan doesn’t come without its fair share of fees. Your lender and other third parties charge fees for closing your loan – costs that can run you thousands of dollars. But will you at least get some relief at tax time? Can you deduct these closing costs on your federal income taxes?

In most cases, the answer is “no.” The only mortgage closing costs you can claim on your tax return for the tax year in which you buy a home are any points you pay to reduce your interest rate and the real estate taxes you might pay upfront.

What Are Closing Costs?

When home buyers take out a mortgage loan, they must pay closing costs. These costs are how lenders and other third parties – such as title insurance providers – make their money. Buyers can expect to pay about 3% – 6% of their loan amount on closing costs. For example, on a $200,000 mortgage, buyers can expect to pay $6,000 – $12,000 in closing costs. Home buyers will receive a Closing Disclosure at least 3 business days before closing that will itemize their closing costs.

Tax deductions are items that you can claim on your federal tax return to reduce your taxable income. These deductions lower the amount of taxes you’ll pay in a given year. Taxpayers can either itemize their taxes, calculating their individual deductions, or they can claim a standard deduction and not itemize.

The 2017 Tax Cuts and Jobs Act increased the standard deductions that taxpayers can claim. Single taxpayers and married individuals filing separately can claim a standard deduction of $12,550 for the 2021 tax year. Those married and filing jointly can claim a standard deduction of $25,100. You’d only itemize your taxes, then, if you could generate individual deductions that top those standard deduction numbers.

Two of the more valuable deductions are related to homeownership. The mortgage interest deduction allows you to deduct the interest you pay on your mortgage each year. You can deduct a total of $1 million or $750,000 in interest depending on whether you bought your home before or after December 16, 2017. You can also deduct the property taxes you pay each year, up to $10,000.

Unfortunately, not many closing costs are tax-deductible. Two exceptions are any points you buy to reduce your loan’s interest rate, and any property taxes you pay in advance.

Property taxes are always deductible. When you take out a mortgage loan, though, you’ll usually have to pay some property taxes upfront, before they’re due. That’s because lenders typically create an escrow account for borrowers.

In an escrow arrangement, you’ll pay extra money with your monthly mortgage payment to cover the costs of your yearly property taxes and homeowners insurance. When your insurance and tax bills are due, your lender will dip into these funds and pay them on your behalf. Once tax time rolls around, you can deduct any property taxes that you paid in advance.

Mortgage points are also tax-deductible. Home buyers purchase these points to lower the interest rate on their mortgages, with each point costing 1% of their total loan amount. For instance, one point on a mortgage loan of $200,000 would cost $2,000. Each point typically drops a borrower's interest rate by 0.25%. One point, then, would lower a mortgage interest rate of 5% to 4.75% for the life of a mortgage loan.

Points can pay off in lower interest costs throughout the life of a loan. They can also help at tax time. The IRS allows you to deduct the full amount of your points in the year borrowers pay for them. To claim this deduction, your mortgage must be used to buy or build your primary residence.

Typically, the only closing costs that are tax deductible are payments toward mortgage interest, buying points or property taxes. Other closing costs are not. These include:

• Abstract fees
• Legal fees (including fees for the title search and preparation of the sales contract and deed)
• Recording fees
• Owner’s title insurance
• Credit check fees

There is one tax benefit to these costs, though. You can add these closing fees to the cost basis of your home when you sell it. This lowers the amount of profit that you make. This can help reduce any capital gains tax you might have to pay on your home.

When you sell a home, you won't have to pay capital gains taxes on the first $250,000 of your sale if you are single or $500,000 if you’re married. For example, if you’re married and sell your home for a $300,000 profit, you won’t have to pay any capital gains taxes on it.

However, if you’re married and sell your home for $600,000, you’d have to pay capital gains taxes on $100,000 of your home sale. You can, though, as we just mentioned, reduce this tax burden by adding your cost basis – that’s where your loan closing costs come in – and the costs of any improvements that you made to the home.

You do have some flexibility in when you can claim those closing costs that are tax deductible.

In The Year Of Closing

If you itemize your taxes, you can usually deduct your closing costs in the year in which you closed on your home. If you close on your home in 2021, you can deduct these costs on your 2021 taxes.

If you purchased mortgage points, though, things can get more complicated. You can deduct the cost of mortgage points in the tax year in which you purchased them if you meet the following rules laid out by the IRS:

• The mortgage loan must be used to buy or build the borrower’s primary residence.
• Paying points must be a long-standing business practice in the area where the loan is closed. The amount you paid for points must be average for the area.
• Either the buyers or sellers must pay for the points, and those payments must be documented.
• You’re not allowed to borrow the funds used to pay for points.
• The amount you paid must be clearly shown and itemized on your loan’s closing disclosure or settlement statement.

Over The Lifetime Of The Mortgage

You can choose to spread out the deduction for mortgage points over the life of the mortgage. There might be years in which it makes more financial sense to claim the standard deduction than it does to itemize. You can hold off, then, and only claim the points deduction in those years in which you do itemize.

When you refinance to a mortgage loan with a lower interest rate, you’re replacing your primary mortgage with a new one. Because of this, a refinance is considered the same as a primary mortgage for tax purposes. This means that the same closing costs – those used to prepay property taxes and those used to buy down your interest rate – are the only ones that can be deducted on your federal income taxes. Using your refinance for tax purposes, as well as lowering your interest rate, can be a great way to maximize your savings.

If you’re closing a cash-out refinance, where you refinance for more than what you owe on your existing mortgage and take the difference as a lump-sum cash payment, you might be able to use the proceeds to adjust the cost basis of your home, reducing your capital gains tax when you eventually sell. You can only do this, though, if you use the money from your cash-out refinance to make capital improvements to your home. You can speak with a tax advisor for further insight.

Here are some additional questions you may be considering when it comes to closing costs on your home and tax deductions.

Are private mortgage insurance or mortgage insurance premiums tax-deductible?

Depending on the loan you take out, you might have to pay for private mortgage insurance (PMI) or mortgage insurance premiums (MIP). If you take out a conventional mortgage loan and don’t put up a down payment of at least 20%, you’ll have to pay PMI, a form of insurance that protects the lender in case you stop making your mortgage payments. MIP is similar, but you’ll have to pay this insurance when you take out a loan insured by the Federal Housing Administration, better known as an FHA loan.

Whether these forms of mortgage insurance are deductible depends largely on the tax year. Congress routinely changes the status of mortgage insurance. For instance, in tax years 2018, 2019, 2020 and 2021, this form of insurance is tax deductible.

What settlement forms do I need for a mortgage loan?

Before you close on your mortgage loan, your lender is required to send you a Closing Disclosure, a five-page form that lists how much you will pay in fees and other closing costs. Your lender is required to send this form to you at least 3 business days before you close on your mortgage.

Are all closing disclosure documents acceptable?

Closing disclosures for conforming mortgages are based on forms created by the Consumer Financial Protection Bureau and are fairly standard throughout the mortgage industry.

How much property tax can I deduct?

Before the 2017 Tax Cuts and Jobs Act went into effect, all state and local taxes – commonly known by the acronym “SALT” – were 100% deductible. This included property taxes. The Tax Cuts and Jobs Act now limits the SALT deduction to a maximum of $10,000, a limit that has been in place since 2019.

How much mortgage interest can I deduct?

You can still deduct the interest you pay on your mortgage loan each year. But the Tax Cuts and Jobs Act did place some limits here, too. If you purchased your home before December 16, 2017, when the act went into effect, you can deduct the interest payments you make on up to $1 million in mortgage debt. If you bought your home after that date, you can deduct the mortgage interest you pay on up to $750,000 in mortgage debt.

Even if you can’t deduct all your closing costs, the U.S. tax code still encourages people to buy homes through the mortgage interest and property tax deductions. In addition, refinancing can be a great way to save money on mortgage interest long-term. Ready to take advantage of all the benefits you can be receiving by buying real estate? Read more about the tax advantages of real estate and see how you can make the most of real estate tax breaks.