Not everyone has a rich relative to help with the costs of purchasing a home. However, just about everyone can use the tax breaks offered by Uncle Sam that allow you to deduct certain closing costs on your tax return. Knowing the tax deductions that you can take helps you better determine how much you can afford to put down as a down payment -- or whether you really would need a rich relative to help you out.
The IRS permits a deduction for the cost of "points" paid at closing. These points include loan-origination fees, maximum loan charges, loan discount, or discount points, as of publication. The IRS allows you to include points that are paid by the seller of the home as part of the agreement. The points must be reasonable for the area in which the loan is made. Examples of nondeductible costs include attorney's fees, attorney fees, and appraisal fees.
When to Deduct Points
If you take out a first mortgage, you have the option to deduct all of the points you pay in that year or to amortize them over the life of the mortgage. Amortizing means that you divide the points over the number of months in the mortgage. For example, if you take out a 15-year mortgage (180 months) and you paid $3,600 in points, you would amortize your points by deducting $20 per month.Often, you are better off taking the entire deduction in the year you take out the mortgage. However, if you cannot itemize your deductions in the year you take out the mortgage, you might be better off amortizing.
Prepaid Mortgage Insurance Premiums
If you put down less than 20 percent as your home down payment, you probably will have to pay for private mortgage insurance, and some lenders will require prepayment of part of the payment at closing. Similarly, if you get a mortgage through the Department of Veterans Affairs, you have to pay a funding fee, which is a recognized form of mortgage insurance. When you pay for mortgage insurance premiums that will apply to future years at closing, you must spread the cost over the shorter of 84 months or the life of the mortgage. For example, if your pay a funding fee and you close your mortgage with five months remaining in the year, you would be able to deduct 5/84ths of the funding fee in the first year.
Limits in Private Mortgage Insurance
Not everyone who pays for private mortgage insurance at closing can deduct it on their tax returns. Only mortgages originated after 2006 are eligible for a deduction for mortgage insurance premiums. In addition, only taxpayers with an adjusted gross income below the annual limits can claim a deduction. As of the 2011 tax year, taxpayers must have an income below $109,000 ($54,500 for married couples filing separately). If the income exceeds this limit, you cannot claim the deduction.
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