While not all closing costs are tax deductible, you may deduct real estate taxes, mortgage interest and mortgage insurance premiums you paid when you bought your home. A standard form implemented by the Department of Housing and Urban Development summarizes your closing costs. To deduct closing costs found on this HUD-1 statement, you must itemize deductions on Form 1040, Schedule A of your federal tax return. You can add costs that aren't deductible to the price of your property, or cost basis, for future tax exemptions.
Deducting Property Taxes
You begin owing property taxes on the day you become a new homeowner and you can deduct your share of those taxes. The escrow holder calculates and lists your share on the HUD-1. For example, if you close on June 16, you prepay 14 days of June's property taxes, which you can deduct. You can also deduct the months you paid at closing for the upcoming tax bill. If the seller paid the full year of property taxes earlier in the year, escrow credits the seller the portion they covered for the time period after the sale, effectively, reimbursing them.
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Taking Prepaid Interest Deduction
You can deduct the home mortgage interest you paid provided that your total mortgage balance does not exceed $1 million, or $500,000 if you are married filing a separate return. Interest you pay in advance in the form of "points" is deductible as long as the HUD-1 shows these loan costs. Points include the origination fee you pay the lender for making the loan. You can also deduct "discount points," or prepaid interest that lowers your loan's interest rate. You may deduct the full amount or a portion over time, depending on the type of points paid.
Qualifying for Mortgage Insurance Deduction
If your mortgage loan is backed by the Department of Veterans Affairs or the Department of Agriculture, you can deduct the full amount of the government mortgage insurance. They appear on the HUD-1 as a "funding fee" for VA loans and a "guarantee fee" for USDA loans. If your loan is insured by the Federal Housing Administration or by a private mortgage insurance provider, you can only deduct a portion, since you don't pay the insurance premiums up front, but annually.
Adding Certain Costs to Basis
You can add certain costs on your HUD-1 that aren't tax deductible to the cost basis of your home. Include state transfer taxes, title fees, attorney fees and recording fees. If you agree to pay any of the seller's expenses at closing, such as real estate commissions or property tax liens, you can add these costs to the home's cost basis to reduce your tax liability when you eventually sell.