Purchasing a home is an extraordinarily expensive process, especially once you add up the down payment, closing costs, and potential relocation expenses. And once you’ve acquired the home, you still need to consider the ongoing taxes, mortgage payments, and associated costs like HOA fees, insurance, and home maintenance costs.
Many people understandably wonder what costs and expenses could be tax-deductible and what additional taxes they may need to pay as part of the homebuying and ownership process.
Here, we’ll go over everything you need to know about taxes and home purchases, including what you’ll pay, potential deductions you may benefit from, and more.
Expected Taxes When Buying a New Home
When buying a home, the taxes you may need to pay depend entirely on your location and your home purchase agreement with the seller.
A common tax is a real estate transfer tax (also sometimes called a “deed transfer tax” or a “documentary tax stamp”). This is a one-time tax or fee charged by state or local governments when property ownership transfers, typically based on the price of the property you’re purchasing.
In some locations, it’s standard for sellers to pay for transfer taxes, though it’s standard for buyers to cover it in others. And even if it’s standard for sellers to cover this tax, they can always negotiate for buyers to pay for it in their closing costs.
Buyers with mortgages are often required to pay a portion of their home insurance payments or estimated property taxes as part of their closing costs. These payments go into an escrow account, which pays home insurance and property tax costs when due.
Additional homebuying costs (and their tax implications)
In addition to real estate transfer taxes and payments for property taxes for escrow, there are additional homebuying costs that buyers should account for.
Common closing costs for buyers may include:
- Deed recording fees
- Home inspection
- Title insurance
- Home appraisals
- Costs of a real estate attorney in states that don’t use title companies
- Private mortgage insurance (PMI) if your down payment is less than 20% of the home price
Unfortunately, the only costs that are typically tax-deductible are interest points you pay down (which we’ll discuss) and any property tax you pay upfront.
Can You Deduct the Down Payment on a New Home on Your Taxes?
Unfortunately, new homeowners cannot deduct down payments for a new home on your tax return. Down payments are considered to be part of the cost basis of a property, which is the purchase price of a real estate property. This is typically true for both personal home purchases and real estate investment property purchases.
Prepaid Interest Points—A Deductible Opportunity
While the down payment and standard closing costs for a new home purchase are typically not tax-deductible, the good news is that prepaid interest points can be.
When purchasing a home, buyers have the option to purchase “points,” which reduces their interest rate for the lifetime of the loan. Buying down points is like prepaying interest, and it will lower your monthly payment. Each individual point may reduce your interest rate by 0.25 points, and the cost of the points are based off the value of the loan.
Typically, if you prepay interest, you must allocate the interest over the tax years to which it applies, which essentially spreads it over the loan. That said, purchasing points on a mortgage for your principal residence is an exception, and in many cases you can deduct the total cost of the points in the tax year you purchase the home.
Taxes After the Purchase
After you purchase the home, there will be additional taxes to consider—and tax deductions you may be able to take advantage of. Let’s take a look at each.
Property taxes
Property taxes are a significant ongoing cost that homeowners need to account for, and they can (and in many cases, will) increase in cost over time.
Different states have unique processes for calculating property taxes. In Florida, for example, property taxes are calculated based on the price value of the home, though they have a homestead exemption that limits how much your property tax can increase year over year.
As a result, there can be drastic jumps when new homeowners purchase a home in Florida; when I bought my first home in Florida, for example, my property tax doubled compared to what the previous homeowner paid.
When I relocated to Connecticut, I discovered that the millage rates were much higher than in Florida, and each individual town had their own mill rates—which were significantly higher than what we’d paid in Florida. Consider talking to your lender and a financial advisor to ensure you know what your property tax will be and that it fits into your monthly budget.
Fortunately, you can deduct local and state taxes (including real estate taxes) up to $10,000 a year on your 2023 federal return. To do so, you must have paid them either at settlement or closing, or to a taxing authority during the year.
Ongoing tax deductions for homeowners
In addition to property tax deduction, new homeowners should talk to their accountant about the following being tax-deductible:
Real estate investors have additional costs that can be used as tax deductions or business expenses to reduce their tax burden. These may include:
- Costs of renovations
- Depreciation of property assets
- Insurance costs
- Maintenance fees
Seeking Professional Advice
Whether you’re a new soon-to-be-homeowner or a real estate investor, any kind of property is a major purchase. For this reason, we strongly recommend working with a trusted and experienced tax and financial service provider.
Financial and tax experts can help you determine not only how much you can afford to spend, but also help you determine what taxes you’ll likely have to pay based on your desired property value and location. They can also provide invaluable advice about what tax deductions apply to your specific situation—and how to go about actually getting those deductions.
Final Thoughts
Unfortunately, the down payment for a new home is not tax-deductible, since it counts towards the cost basis of the home itself.
Many closing costs also aren’t tax-deductible—but the good news is that there are tax deductions associated with homeownership, often including mortgage interest, property tax, and potential home office deductions. Real estate investors typically have even more costs that are either tax-deductible or that can count as business expenses, reducing their overall tax burden either way.
Ultimately, working with a qualified tax and financial expert is the easiest way to ensure that you’re taking advantage of every tax break possible, whether you’re buying a personal residence or a new investment.
Dreading tax season?
Not sure how to maximize deductions for your real estate business? In The Book on Tax Strategies for the Savvy Real Estate Investor, CPAs Amanda Han and Matthew MacFarland share the practical information you need to not only do your taxes this year—but to also prepare an ongoing strategy that will make your next tax season that much easier.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
