Closing on a loan can cost you several thousand dollars. Before you let that prevent you from buying a home or refinancing, learn which settlement statement items are tax deductible. This lowers the overall cost of closing on a loan, by lowering your tax liability at the end of the year.
Buyer Tax-Deductible Expenses
As a buyer, you’ll likely see the largest number of tax-deductible expenses. Most of these deductions apply strictly to the purchase of a primary residence or second home. Investment properties are often subject to different rules.
- Loan origination fees – An origination fee is something the lender charges to process your loan. Sometimes they reserve this fee for ‘difficult to process’ mortgages. Some lenders, however, charge this fee on every loan. No matter the reason, the IRS views this as prepaid interest. Just like you can deduct your mortgage interest paid on your loan both at the closing and monthly, you can deduct the loan origination fee on your taxes.
- Discount points – If you want a lower interest rate, you may have to pay discount points. This is yet another form of prepaid interest. The lender accepts an upfront payment in exchange for a lower interest rate. In other words, they make the interest now, rather than over the term of the loan. You can deduct this cost on any primary or second home.
- Prepaid mortgage interest – Any interest you pay upfront (at the closing) may be written off on your tax returns. You’ll usually prepay interest for the remainder of the month that you are closing. For example, let’s say you close on March 15th. You’ll pay interest for the remainder of the month because your first mortgage payment would not begin until May 1st. Mortgage interest is paid in arrears. This means the May 1st payment would cover the interest from April. That leaves half of March’s interest unpaid. You pay it at the closing and then get to deduct it on your taxes.
- Real estate taxes – If you pay real estate taxes at the closing, you may be able to deduct them on your taxes. You must be able to prove that you actually owed the taxes for that year. If you buy a home where a seller is behind on taxes and you agree to pay them, you cannot deduct them on your tax return. You must owe them, meaning, it’s for time when you own the home.
Seller Tax-Deductible Expenses
Sellers have certain fees as well that sometimes result in a tax deduction; however, they have a different scenario. Generally, the fees sellers owe come right out from the proceeds of the sale. This in turn, reduces their capital gains, which reduces their tax liability. So while sellers don’t have many fees they can write off directly, they do get a pretty decent deduction by default. There is one fee that sellers can definitely deduct, though, outside of the decreased capital gains:
- Real estate taxes – Sellers are responsible for the portion of the taxes that are billed for the time they lived in the home. For example, if the bill comes out in September, and you close in August, you’ll owe the taxes for the entire year up to September. The buyer will be responsible for the taxes from September through the end of the year. You can then deduct the taxes that you owed on your tax return.
Refinancing and Tax Deductions
Even if you refinance, you may be able to deduct some of the costs on your settlement statement.
- Prepaid interest – Just as you can write off prepaid interest as a buyer, you can write it off when you refinance too. It’s the same thing if you kept your current mortgage and kept paying the mortgage interest. Any interest you pay, you can use as a tax deduction on your taxes. Don’t forget to include the prepaid interest on your Loan Closing Statement in your taxes.
- Points paid – Again, lenders may charge origination fees or discount points. Luckily, the IRS lets you deduct these items even if you refinance. The difference, however, is how you deduct them. You can’t take the entire deduction at once. Instead, you’ll have to prorate the points over the life of the loan.
The best way to make sure you get all of your tax deductions is to talk to your tax advisor. With the Tax Reform and tax deductions changing so drastically, it’s best to get a professional opinion. As long as you make sure you tell your advisor about your home purchase, sale, or refinance and prove payment of the tax-deductible expenses, you may be able to lower your tax liability.Click to See the Latest Mortgage Rates»