Tax season is the least favorite time of year for many Americans — and not just because they end up owing money to the government.
It’s also stressful for those trying to figure out what they can deduct from their taxes to reduce their bill. If you bought a house during the previous year, you might be in luck: Many of the costs associated with your home purchase are “deductible,” meaning they can be used to lower your taxable income.
Tax deductions aren’t a “dollar-for-dollar” reduction in your tax bill, but they can help lower it.
But like everything involving taxes, it’s not simple. Here’s what you need to know about what closing costs you can, and can’t, deduct from your taxes.
What Are Closing Costs?
The term “closing costs” covers a wide array of expenses that come along with a home purchase. They include “really anything associated with the actual closing on the property,” a process that involves many different professionals and services to pay for, according to Marianela Collado, a certified financial planner, senior wealth advisor and CEO of Tobias Financial Advisors in Florida.
The most common closing costs are real estate agent commissions, title agency costs, legal fees, loan origination fees and prepaid taxes and insurance. Though they may seem like an unnecessary burden, the fees that comprise closing costs all contribute to making sure your home purchase is done properly.
“Closing costs are those one-time fees when you take out the loan, and it’s just the cost of getting the loan,” says Katie Bossler, quality assurance specialist at GreenPath Financial Wellness.
What Does Tax Deductible Mean?
It doesn’t necessarily mean you’ll pay less in taxes. “A tax deduction represents a reduction in your taxable income, not necessarily a reduction in the tax bill,” Collado says. In other words: If you earn $60,000 per year, and you deduct $10,000 in qualifying expenses from your income, that means your taxable income is now $50,000.
“Some people confuse that with a dollar-for-dollar reduction on your tax bill, and that’s not what that means,” Collado says.
So that $10,000 deduction wouldn’t mean your tax bill is $10,000 less. But when you reduce your taxable income, it does have the potential to shrink your tax bill a bit, and deducting your closing costs could help you do that.
Also keep in mind that you’ll need to itemize deductions on your tax return to take advantage of these opportunities, with all your deductions adding up to more than the standard deduction of $25,900 for a married couple and $12,950 for an individual in tax year 2022, according to the IRS. Most taxpayers take the standard deduction instead.
Closing Costs That Are Tax Deductible
If you’re purchasing a single family home that is your primary residence, Collado says there are only a couple of closing costs you can deduct from your taxes:
- Prorated property taxes: Sometimes, homebuyers will pre-pay a portion of their local real estate taxes at the closing table. This cost is tax-deductible.
- Mortgage interest: Homeowners can deduct mortgage interest every year, not just when they purchase a home. But mortgage interest you pay at the closing and during the first year of home ownership is certainly tax-deductible.
- Mortgage points: If you paid “points” upfront to reduce the interest rate on your mortgage, that cost is also tax-deductible, Bossler says.
Closing Costs That Aren’t Tax Deductible
Basically all other closing costs for single family, primary residences are not deductible:
- Attorney fees: The money you pay for your lawyer during the closing process.
- Title costs: Any title search or title insurance fees.
- Private mortgage insurance: The additional fee that mortgage lenders charge to certain high-risk borrowers.
- Real estate agent commissions: The money you pay a real estate agent at the closing.
- Appraisals and home inspections: The costs associated with inspection and valuation of the home you are purchasing.
Do You Have to Claim Closing Cost Tax Deductions the Same Year You Get the Mortgage?
When you can deduct your closing depends on what type of home you’re buying, and which costs you’re trying to deduct.
The Year of Closing
Most buyers, including those who are purchasing a primary, single-family residence, would need to deduct their closing costs the year of the closing, Collado says. There isn’t much flexibility to this: If you want to deduct these costs, you have one year to do it.
For example, if you purchased a home in 2022, you would deduct that cost from your 2022 taxes when you file them in the spring of 2023.
Spread Out Over the Life of the Loan
If you’re purchasing a multi-family or investment property, you have a lot more options. “That’s when it’s a game-changer,” Collado says.
In that case, you can deduct a wider range of costs (including title, legal and commission fees), but you can also spread out these costs as part of the “cost basis depreciation” that lasts 27.5 years. It can get complicated, so in this situation it’s best to work with a tax professional.
Is PMI or MIP tax-deductible?
Buyers who are mortgaging more than 80% of the value of the home will likely be paying PMI, or private mortgage insurance, which is a fee that lenders charge to cover the additional risk of these types of loans. For a single-family home you live in, this cost is not deductible, Collado says. But multi-family home and investment property owners can deduct this cost.
Are property taxes tax-deductible?
Property taxes are fees that homeowners pay each year to their local municipalities to fund all types of services, like police and fire departments. These costs are tax-deductible, especially if they were part of your closing costs.
Is mortgage interest tax-deductible?
Mortgage interest is the cost of borrowing money — that 5% or so on top of what you actually owe. Especially in the early years paying off your mortgage, most of what you’re paying is interest, and that cost is definitely deductible if you itemize, Collado says.