What are Tax Deductions?
Tax deductions refer to the expenses that can be claimed on an individual’s federal tax return to decrease their taxable income. By availing these deductions, the amount of taxes payable in a particular year can be reduced. Taxpayers have the option to either itemize their taxes by calculating their individual deductions or claim a standard deduction without itemizing.
What are Closing Cost?
Closing costs refer to the fees that a homebuyer is required to pay at the time of closing. These costs typically range between 2% and 3% of the total loan amount borrowed. It is important to note that the amount of closing costs is not calculated on a percentage basis, but rather as a sum of specific line items and lender fees.
Which closing cost are Tax-deductible?
Regrettably, only a few closing costs are eligible for tax deductions. However, there are two exceptions to this rule: points purchased to reduce the interest rate on a loan and property taxes paid in advance. Property taxes are always deductible, but when obtaining a mortgage loan, borrowers are typically required to pay some property taxes upfront, which are then placed in an escrow account by the lender. Mortgage points are also tax-deductible. These points are purchased by home buyers to lower the interest rate on their mortgage, with each point costing 1% of the total loan amount. For example, one point on a $200,000 mortgage loan would cost $2,000 and typically reduce the borrower’s interest rate by 0.25%. One point would lower a 5% mortgage interest rate to 4.75% for the duration of the loan. Purchasing points can result in lower interest costs throughout the life of the loan and can also provide tax benefits. The IRS permits borrowers to deduct the full amount of their points in the year they are paid for, provided the mortgage is used to purchase or construct their primary residence.
When are closing cost Tax-deductible?
The Year You Closed
If an individual itemizes their taxes, they may typically deduct their closing costs in the year in which they closed on their home. Specifically, if one closes on their home in 2023, they may deduct these costs on their 2023 taxes. However, if an individual purchased mortgage points, the matter becomes more complex. The cost of mortgage points may be deducted in the tax year in which they were purchased if certain rules established by the IRS are met. These rules include that the mortgage loan must be used to purchase or construct the borrower’s primary residence, paying points must be a customary business practice in the area where the loan is closed, the amount paid for points must be average for the area, either the buyer or seller must pay for the points and document the payment, the funds used to pay for points cannot be borrowed, and the amount paid must be clearly itemized on the loan’s closing disclosure or settlement statement.
Over The Life-Span of Your Loan
In the event that tax deductions cannot be claimed for the purchase of a house during the year in which closing costs are paid, it is possible to avail of them over the duration of the loan. This can be achieved through the deduction of points paid on a purchase loan, which may remain deductible for as long as the mortgage is in effect. Similarly, points paid on a home improvement refinance loan can be deducted over the remaining loan term, provided that only a portion of the loan proceeds were utilized for home improvement purposes.
Where can I find my closing cost information?
Form 1098, a tax document pertaining to mortgages, is issued by your mortgage company and solely contains details regarding the mortgage interest and property taxes paid during the preceding year. To confirm the tax-deductible closing costs, it is imperative to obtain a copy of your closing disclosure.
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