When you buy that dream house, you have to shell out what are called closing costs at, yes, closing. Many of these expenses are not tax deductible, but a few may be allowed. Legal fees, home appraisal, recording fees, title and homeowners insurance, private mortgage insurance and some lender fees are not deductible. If you must prepay some interest (if you close on a date other than the first or last day of a month), any pro-rated property tax and points (one point equals 1 percent of your mortgage), these are typically tax deductible.
Prepaid Interest
All contemporary mortgage loan notes are written and dated as the first of the month. Unlike rent, due in advance for the upcoming month, mortgage loan payments are due on the first but cover the month before. Therefore, if you close on any day but the first or last day of a month, you will owe the lender some prepaid interest. For example, you close on the 25th of a 30-day month, e.g., September. You must pay your lender five days' interest to cover the remaining days in the current month. However, you won't need to make a mortgage payment until Nov. 1 (around 35 days), since your first payment is not due until the first day of the month after you own the home. All interest is tax deductible.
Property Tax
Real estate property taxes are deductible. While you usually pay these taxes in arrears, in some cases, depending on your closing date, you may have some pro-rated property tax payable at the closing. So this expense is deductible, although it is included in your closing costs. Property taxes, like mortgage loan interest, are deductible when you pay them. Depending on the dates that your city or town or other governmental jurisdiction requires property tax payments, you may have to pay this tax when you close on your home.
Lender Points
Lenders charge one or both of two types of points. Origination points go directly to the lender to increase their income. Discount points are paid to the mortgage purchaser, typically the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), the Veterans Administration (VA) or the Federal Housing Administration (FHA). These points lower your note's interest rate. Points are tax deductible when they are paid. Even if the seller agrees to pay these points, the buyer can deduct them, but the seller then cannot also take these as a deduction.
IRS Deductible Regulations
A home appraisal, credit report, title, legal and most other expenses are not deductible. Avoid the temptation to treat these expenses as points or other tax-deductible items since the IRS has seen this manipulation many times and scans for taxpayer attempts to gain benefits of deductibility. Always discuss this issue with your tax adviser before you buy a home because tax rules change frequently, and a major tax modification could enhance or restrict some deductible expenses. This also helps you to avoid expecting deductions that do not exist or missing some tax benefits of which you are unaware.