There are many different types of fees and charges a home buyer must pay to get a loan and complete the purchase. For tax purposes, these expenses fall into three categories:
- deductible expenses
- expenses added to the home's tax basis, and
- nondeductible expenses.
Here's an overview of these expenses, including how to get a tax benefit out of expenses you can't deduct. For articles on tax deductions and credits available once you own a home, see the Taxes for Homeowners section of this site.
When you buy a home to live in, the only expenses you may deduct for income tax purposes are those for prepayment of interest or any points you pay to obtain a loan.
Expenses Added to Basis
Expenses you must pay to obtain title to your home are added to the home's tax basis. This means the expenses will increase the value of the home for tax purposes, and reduce the amount of any taxable profit you realize when you sell the home. These expenses include:
- legal fees to obtain title to the home
- title search fees
- title insurance
- title recording fees
- transfer taxes, and
- survey fees.
You can also add to basis any expenses of the seller that you agree to pay, such as real estate broker commissions.
The remaining costs you incur to purchase a home are neither deductible nor eligible to be added to your home's basis. As far as taxes go, they are useless. These costs include all the costs you incur to obtain a home loan--for example:
- appraisal fees
- mortgage broker's commissions
- pest inspection fees
- credit report fees
- loan fees (not points)
- mortgage insurance premiums, and
- commitment fees.
You also can't deduct or add to your home's tax basis hazard insurance premiums, homeowners' association fees, or utility fees.
Getting Tax Benefits from Nondeductible Expenses
What can you do to get some tax benefit from these nondeductible expenses? The best strategy is to have the seller pay these expenses and add the cost to the price of the home. This will increase the home's basis and reduce any taxable profit when you sell. Meantime, the seller treats these costs as selling expenses that reduce his or her gain from the sale. So increasing the home's sales price will not result in extra tax for the seller.
Example: Roberta agrees to buy a home from Robert for $500,000 and incurs $4,000 in closing costs that can't be deducted or added to the home's basis. She asks Robert to agree to pay the $4,000 himself and increase the sales price to $504,000. Robert agrees because he'll be able to deduct the $4,000 from his gain. Thus his gain is the same whether he pays the $4,000 or Roberta pays it. Roberta now has a home with a $504,000 basis instead of $500,000, which will reduce her profit by $4,000 when she sells her home.
How Increasing Your Home's Tax Basis Helps
Of course increasing your home's basis will only benefit you if, when you sell, your profit exceeds the $250,000 or $500,000 home sale tax exclusion, or you don't qualify for the exclusion. For example, if Roberta qualifies for a $250,000 exclusion and realizes a $200,000 profit when she sells the home, the fact that the home's basis is $504,000 instead of $500,000 makes no difference. Her entire gain is tax free either way. On the other hand, if Roberta earns a $300,000 profit on the sale, the extra $4,000 in basis will save her from having to pay tax on $4,000 of her $50,000 in profits that exceed the $250,000 exclusion.
More Real Estate Tax Information
See IRS Publication 530, Tax Information for Homeowners, for detailed information about the tax benefits of buying a home.