Closing on a home can be expensive – including the various loan-related fees and points, inspections, insurance, interest, property taxes, and title search expenses, it can add up fast. However, the good news is that some of these items on the HUD-1 settlement statement are tax-deductible. It's important to understand which of these items can be deducted for federal income tax purposes to partially offset your closing costs. Here's what you can expect on this HUD document for taxes.
Prepaid Property Taxes
The HUD-1 settlement statement for taxes itemizes closing costs, including prepaid items such as real property taxes and mortgage interest. Since those taxes may have been already been paid by the seller for a period after closing, as the buyer you will repay this amount to the seller at closing.
Accordingly, prepaid real estate taxes are prorated using the number of days the seller has owned the house over the tax year. Since real estate taxes are one of the HUD statement tax deductions, if you opt to itemize, then you can deduct the amount listed on the settlement statement.
Mortgage Loan Points
When taking a look at a HUD statement example, you'll find mortgage loan discount points listed. Generally, these are tax-deductible in the tax year that you purchase and close on your primary residence.
The mortgage must be for the purchase of your primary residence; you must pay more in cash at closing than points; and the points do not include other hidden fees. Each discount point represents a percentage point of the loan and is applied against its interest rate.
Notably, if the seller is going to pay some or all of the discount points per the purchase agreement, as a taxpayer you are entitled to deduct those points as itemized deductions on IRS Form 1040. Also, to compensate the lender, mortgage loan origination points are often assessed. Provided they do not represent other fees or costs, these origination fees are tax-deductible as well.
Prepaid Mortgage Interest
If the transaction closes on any day before the calendar day that your mortgage payments are due, then you are assessed pre-paid interest at closing for the number of days until the next mortgage payment is due. Since interest typically is not charged in advance, but is charged as it accrues, you generally won't be required to pay your first actual mortgage payment until the month following the closing date. Since mortgage interest is generally tax-deductible, you are entitled to claim it as an itemized deduction for federal income tax purposes.
Non-Deductible Settlement Charges
Some expenses on the HUD-1 settlement statement simply are not tax deductible. However, non-deductible transaction costs do increase the taxpayer's basis in the property, so there will be a smaller gain or a larger loss when the property is ultimately sold. These miscellaneous costs will not provide any immediate tax benefit, but may provide some indirect benefit in the future.
For the 2020 tax year, for example, you could deduct the cost of private mortgage insurance listed on your HUD-1 settlement statement for taxes, but you can't for the 2021 tax year. Other nondeductible items on the HUD-1 settlement statement include real estate commissions, hazard insurance, and the cost to obtain your credit score. Retain all documentation relating to the transaction for future reference and substantiation purposes.
Jeff Clements has been a certified public accountant and business consultant since 2002. He has also worked in private practice as an attorney. Clements founded a multi-strategy hedge fund and has served as its research director and portfolio manager since its inception. He holds a Juris Doctor, as well as a master's degree in accounting.