Many tax benefits accrue from mortgages. It is common knowledge that you can write off mortgage interest and real estate taxes. Less commonly known is that there are a number of deductible closing costs as well, even for refinance loans. Since not every cost is eligible for a deduction, you need to do research before applying eligible closing cost deductions to your taxes.
Any deductible closing costs, along with other deductible mortgage fees, serve to reduce the amount of taxable income. This reduction in taxable income reduces the amount of tax owed. You must choose between the eligible deductions available to you in any given tax year and the standard deduction you qualify for -- you cannot take both. Some Americans do better taking the standard deduction. In 2012, standard deductions ranged from $5,950 for a single person to $11,800 for a married couple filing jointly. Your situation determines which is the better choice for you.
Closing costs related to particular services, such as appraiser's fees, attorney's fees, title insurance and homeowner's insurance, are not eligible for tax deductions. Transfer taxes, even though they are a tax, are not eligible either, though real estate taxes are. This is the case whether the buyer, seller or lender pays for them. This holds true for both purchase and refinance loans.
Many monthly mortgage fees, such as mortgage interest, mortgage insurance and real estate taxes, are paid at a prorated amount at closing to create an up-to-date escrow account. Advance escrow payments are eligible for tax deductions in the year the closing takes place, since these are already allowable deductions.
Any discount points used to pay for interest reductions or for loan origination are deductible. While both are deducted in the year the loan closes for purchase loans, only the origination points are entirely deductible in the same year for refinances. You must deduct points paid to reduce the interest rate on a yearly basis over the life of the loan for refinances. For example, if the total number of points you paid on a refinance is three, but one is for origination and the other two are for the interest rate buy-down, then you take one point as a deduction the year the loan closes and deduct the other two over the life of the loan.
The only exception to the spread-out of discount point deductions is for points paid on a refinance or portion of a refinance dedicated toward home improvements on your primary residence. You deduct this portion in the year the loan is closed. Using the original example, if 25 percent of the loan amount is used for improvements, then half a point of the two points of the interest buy-down is deducted the year the loan closes and the remaining 1 1/2 points get deducted over the life of the loan.
If you refinance with a government-backed loan that features an upfront mortgage insurance or funding fee, such as Federal Housing Administration, Veterans Administration or U.S. Department of Agriculture Rural Development loan, this fee is tax-deductible. It does not matter if you pay the fee upfront or finance the fee in the loan. You take the deduction for the full amount in the year you close the loan.