Are Closing Costs Tax Deductible? What You Need to Know Before Filing With the IRS

Tax deductions are vital to many homeowners’ budgets. Understanding the tax code and how it applies to your housing situation allows you to save thousands of dollars, which can be used to pay down the mortgage or fund home repairs and renovations.

Many new homeowners ask: Are closing costs tax deductible? This is an important question, as are the ten critical homeowner tax questions discussed below.

Are Closing Costs Tax Deductible?

Closing costs for a home purchase are not tax deductible. They include title fees, commissions, insurance and other expenses often split between the buyer and seller. When asking “are closing costs are tax deductible,” many people also wonder if mortgage interest and property taxes paid at closing are eligible. If any of these items are part of the closing costs, they are tax deductible in the year they are paid if the taxpayer meets other qualifications.

The ability to deduct closing costs is an important consideration for homebuyers. Once the home is purchased, the new owner takes on much more responsibility during tax season. Homes come with greater expenses than rental properties and many more tax deductions. Understanding these deductions can make or break a homeowner’s budget.

Top Ten Tax Questions Homeowners Need to Know Before Filing Their Taxes

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The Tax Cut and Jobs Act (TCJA) changed the taxing landscape for many homeowners. Strict limits on once far more generous homeowner tax deductions have increased the federal tax bill for many families, especially in areas with high home values. However, there are offsets that can ease or eliminate tax increases. Here are the 10 top tax questions homeowners need the answers to.

Does Mortgage Interest Remain Deductible?

People ask this question just as often as “are closing costs tax deductible?:. The answer is yes, but not everyone can deduct their full interest payments. Under previous tax codes, homeowners with high value mortgages could still take full advantage of the deduction, writing off all interest paid during the year.

Under the TCJA, only the interest paid on the first $750,000 of principal remains eligible for a tax deduction. For example, if a homeowner has a $1 million principal balance, only 75% of the mortgage interest can still be deducted. Married taxpayers filing separately can deduct interest on the first $375,000 of the principal balance.

These new limits apply only to homes purchased after December 15, 2018. Taxpayers who owned homes on December 15, 2017 or before maintain eligibility under the old limits, which allow mortgage interest on the first $1 million to be deducted ($500,000 for married people filing separately).

Mortgage companies report the mortgage interest paid by each taxpayer on a Form 1098, which they send to their customers. Taxpayers must determine if all or some or the mortgage interest paid qualifies for the deduction.

Is Home Equity Loan Interest Still Deductible?

As with mortgage interest, home equity loan interest has been curbed. Previously, homeowners could deduct interest on home equity debt up to $100,000. It made no difference what the $100,000 was used for. Homeowners could use the money for home repairs, to pay off credit card debt, or to start a business. The deduction was guaranteed.

Starting in 2018, home equity loan interest deductibility has been tethered to the reason for the loan. Now, the money must go toward buying, building or substantially improving a primary residence. The $100,000 limit remains in effect.

However, that $100,000 counts toward the $750,000 mortgage interest deductibility limit, so anyone with a principal balance over $650,000 faces limits or total disqualification from the home equity loan interest deduction.

Are Closing Costs Tax Deductible?

Mostly, closing costs don’t qualify as tax deductions. The exception to this is real estate taxes. Property taxes are still tax deductible, so if they are included in closing costs, they are still considered deductible. However, the property tax deduction only applies to taxpayers who itemize their deductions.

Some settlement or mortgage closing costs may qualify at the time the home is sold, so keeping track of your closing cost records is important. Some of these fees can be added to the cost basis of the purchase.

As a result, they lessen any taxable profit you make from a future sale and should be deducted from any capital gain on the home. Since most homeowners qualify for exceptions to the capital gains tax on primary residences, they never need to take these offsets. However, this calculation is important when selling a second home or if the capital gain exceeds the exception’s limits.

Items that qualify as expenses against capital gains include the following:

  • Mortgage-related items
  • Title fees
  • Legal fees
  • Recording fees
  • Title insurance
  • Other fees required to take ownership of the property

Is Mortgage Insurance Tax Deductible?

Mortgage insurance is required for mortgage holders who have less than 20% equity. This insurance protects the lender in case the borrower defaults. Despite this, the burden of paying the mortgage insurance premiums is on the homeowner. As such, deducting these premiums has been a great help to homeowners over the past decade.

The TCJA did not include a provision for mortgage insurance tax deducibility. Congress must renew the deduction each year. They did for 2018 and 2019, but there is no guarantee renewal will continue. Members of Congress have proposed passing a bill to make the deduction permanent.

Limits on the deduction remain and include the following:

  • Deduction reduced when Adjusted Gross Income (AGI) exceeds $100,000 for single filers
  • Deduction reduced when married people filing separately have an AGI above $50,000
  • Deduction eliminated for singles with AGIs above $109,000
  • Deduction eliminated for married taxpayers filing separately if AGI exceeds $54,400

Are Mortgage Points Deductible?

The IRS distinguishes between points paid on loans used for home repairs and loans for purchases and general refinancing. Points are fully deductible in the year they were paid if the loan was taken for the purpose of building, buying or repairing a primary residence.

For example, if you paid $3,000 in points on a construction loan for a primary residence, you can deduct $3,000 on that year’s tax return.

Points on all other refinances and purchases are tax deductible on a prorated basis. This means that the deduction must be divided evenly between each year through the life of the loan. For example, if you paid $3,000 in points on a 30-year mortgage, you can deduct $100 per year over 30 years. Because the proration is so gradual, many taxpayers miss out on this deduction, which hurts them if they refinance or sell the property. When the property is sold or refinanced, the remaining points on the loan become deductible in that tax year.

Are Property Taxes Still Tax Deductible?

State and local tax (SALT) deductions remain in force but with more restrictions. To take SALT tax deductions, taxpayers must itemize deductions. The increase in the standard deduction makes it more advantageous for many taxpayers to take the standard deduction rather than itemizing, even if they pay significant property taxes. In addition, SALT deductions are now capped at $10,000.

Do Capital Gains Taxes Still Apply?

The TCJA did not eliminate the capital gains exemption for principal residences. Single homeowners can pocket $250,000 in capital gains from the sale of their home tax free, while married couples can pocket up to $500,000. To qualify, the homeowner(s) must have lived in the home for two of the previous five years.

Capital gains are calculated according to the cost basis for the property. This means that homeowners can reduce their capital gains for tax purposes. Reductions include closing costs and home improvements. Standard home repairs are ineligible.

Which Is Better, Itemizing or the Standard Deduction?

The answer to this question is completely individual. Determining it is a matter of calculating all itemized deductions and comparing the sum total to the standard deduction. Before making this calculation, be sure to include all itemized deduction opportunities.

What Home Expenses Are Tax Deductible?

Home repairs are not tax deductible and home improvements are. Repairs include fixing appliances, HVAC work and repairing damage to roofs or walls. A vast array of home improvement items qualify for a tax deduction, including the following:

  • Additions
  • Swimming pools
  • New roofs
  • New central air-conditioning systems
  • Extra water heaters
  • New storm windows
  • Intercoms
  • Home security systems

Do Deductions Phase Out As Income Rises?

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The TCJA eliminates any income-based phase out through 2025. As with the mortgage insurance deduction, Congress must renew it or pass a bill making it permanent.

Unfortunately, the answer is no to the question, “are closing costs tax deductible?”. Closing costs are not tax deductible, but as the answers to these ten critical questions reveal, there are many other tax deductibility opportunities available to homeowners. In addition, should the homeowner sell the property and not qualify for a capital gains exemption, the closing costs become tax deductible against capital gains.

Many changes to the tax code affect homeowners. Understanding the new tax bill and how it impacts the family budget is very important. Most homeowners rely on tax deductions to make homes affordable.

To keep on budget, households must know ahead of time how their tax situation will change in the coming year. With solid knowledge of the tax code, homeowners save thousand of dollars every year. This should give them solace when hearing the answer to the question, “are closing costs tax deductible?”.

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