Maximizing Tax Savings: The Complete Guide to Deductible Home Transaction Costs

When purchasing, selling, or refinancing a property, closing costs represent a substantial financial outlay. While most taxpayers benefit from taking the standard deduction, the year you buy or refinance may present a unique opportunity. Certain closing costs can qualify as tax deductions, and these additional deductible expenses might push your itemized deductions above the standard deduction threshold, resulting in significant tax savings.

For 2020 tax returns filed in 2021, the standard deduction stands at $12,400 for individuals, $18,650 for heads of household, and $24,800 for married couples filing jointly. If your itemized deductions—including closing costs—exceed these amounts, you should file Schedule A and itemize rather than take the standard deduction.

Understanding What Qualifies: Not All Closing Costs Are Tax Deductible

A critical misconception exists: every closing cost carries tax-deduction potential. In reality, the IRS permits deductions only for expenses classified as taxes or interest. Knowing which costs qualify can significantly reduce your tax burden, as you may be eligible to deduct far more than you initially assumed.

The Five Major Tax-Deductible Closing Cost Categories

Property Taxes: Your First Deduction Opportunity

State and local real estate property taxes are fully deductible in the year you pay them, provided they’re levied uniformly across all properties in your area to support general public welfare. However, there’s an important limitation: you cannot deduct more than $10,000 annually ($5,000 if married filing separately) across all property taxes, sales taxes, and state and local income taxes combined.

Prepaid Interest: The Often-Overlooked Deduction

Closing typically occurs mid-month, requiring you to pay interest for the partial month until your first regular mortgage payment. If you close on March 10, for instance, you’ll owe interest from March 10 through March 31. This prepaid interest qualifies as a deductible expense, treated identically to regular mortgage interest throughout your loan term.

For mortgage interest to remain deductible, the mortgage must be secured by your home, and loan proceeds must finance the purchase, construction, or substantial improvement of your primary residence or second home. The IRS caps mortgage interest deductions at interest paid on the first $750,000 of mortgage debt ($375,000 if married filing separately). Your lender reports annual interest payments on IRS Form 1098, though payments under $600 aren’t required to be reported—you can still deduct them regardless.

Monthly mortgage payments and any associated late fees also qualify for this deduction.

Discount Points and Loan Points: Prepaid Interest Under Another Name

When you pay points to reduce your mortgage interest rate, the IRS classifies these “discount points” as prepaid interest, making them potentially deductible in the year you pay them. Multiple conditions must be satisfied:

• The mortgage is secured by your primary residence
• Mortgage proceeds are used to buy, build, or substantially improve your primary home
• Paying points represents standard business practice in your locality
• The points paid don’t exceed customary amounts for your area
• You use the cash method of accounting (applicable to most individuals)
• Your lender hasn’t charged you additional points in exchange for reduced fees elsewhere
• Cash brought to closing equaled or exceeded the points amount
• Points are calculated as a percentage of the loan amount
• Your mortgage settlement statement explicitly itemizes points paid

Notably, you can deduct points even if the seller pays them, provided all conditions above are met. When selling later, you’ll reduce the purchase price basis by any seller-paid points.

Understanding Underwriting Fees and Origination Fees: Are Underwriting Fees Tax Deductible?

The IRS classifies mortgage origination fees—including underwriting fees that lenders charge for processing and underwriting your mortgage—as points. This classification answers a common question: are underwriting fees tax deductible? Yes, when properly documented and meeting origination fee criteria. You can deduct your loan origination fees, including underwriting fees, even if the seller covers them. This treatment extends to all lender-charged processing expenses.

These fees typically represent 0.5% to 1% of your loan amount and qualify for the same treatment as discount points.

Mortgage Insurance Premiums: Four Deductible Types

The IRS recognizes four categories of mortgage insurance as deductible: private mortgage insurance (PMI), VA funding fees for VA loans, USDA loan guarantee fees, and FHA loan up-front mortgage insurance premiums.

Mortgage insurance can be structured as monthly payments, a lump sum paid at closing, or a financed amount included in your mortgage. For lump-sum fees paid or financed at closing, you can deduct the entire amount in your closing year. However, this deduction has income limitations: it phases out when adjusted gross income (AGI) exceeds $100,000 (for single filers; $50,000 if married filing separately) and becomes completely unavailable once AGI surpasses $109,000 ($54,500 if married filing separately).

What You Cannot Deduct: Common Non-Deductible Closing Costs

For home purchases, only mortgage interest and property taxes present deduction opportunities. The following closing costs are explicitly non-deductible:

• Home appraisal fees
• Home inspection costs
• Pest inspection fees
• Title insurance premiums
• Escrow account fees
• Notary fees
• Attorney fees
• Homeowners association fees
• Flood determination and monitoring fees
• Home warranty premiums
• Credit report fees
• Transfer and stamp taxes
• Rent payments

Home Sale Closing Costs: A Different Tax Treatment

Sellers face their own closing cost challenges, though different rules apply. If you’ve occupied your home for two of the preceding five years, you’re exempt from taxes on the first $250,000 of profit ($500,000 if married). These exemptions provide far greater tax benefits than deductions.

For profits exceeding these thresholds, increasing your home’s cost basis reduces capital gains tax liability. Your basis equals the purchase price plus maintenance, improvement, and sale-related costs.

Certain non-deductible purchase and sale costs can be added to your basis instead:

• Title search and abstract fees
• Utility installation fees
• Legal fees and recording fees
• Survey fees
• Transfer and stamp tax fees
• Owner’s title insurance

Seller-specific expenses that increase basis include:

• Real estate agent commissions
• Advertising expenses
• Legal representation fees
• Loan charges you paid on the buyer’s behalf
• Staging fees and other sale-related costs

Notably, credit report, appraisal, and homeowners insurance fees cannot be added to your basis and provide no tax benefit.

Strategic Planning for Maximum Tax Efficiency

Understanding these deduction and basis-adjustment opportunities allows you to minimize your overall tax burden. In high-profit sale scenarios or transactions involving substantial points and underwriting fees, consulting a tax professional ensures you capture every available deduction while remaining fully compliant with IRS regulations.