HUD-1 Settlement Statement – Is This Thing Important?

Picture of a calculator, house, and mortgage applicationDid you buy or refinance a home this year?  If so, make sure to hang on to your HUD-1 Settlement statement for your 2016 taxes. If you itemize, you may be able to deduct certain fees on your 2016 tax return.

The HUD-1 Settlement Statement, named after the Department of Housing and Urban Development, is a listing of closing cost and settlement charges paid by the buyer and seller of a home. The addition and subtraction of the amounts on this form are what ultimately determines the amount of your mortgage.

The IRS allows homeowners to deduct part of their closing costs on their federal income taxes.  You must itemize on your 1040 to claim these deductions and the amount of your deduction will depend on if you are purchasing a home or refinancing an existing mortgage.

First, let’s look at the closing costs you can deduct on the purchase of a home, i.e. obtaining a new mortgage. The HUD-1 Settlement Statement is long and has many different numbers. Each section has a unique number along the edge which will help you identify the amounts that may be deductible. The first section to look at is section 106-107.  This will show any prepaid real estate taxes such as City/Town taxes and/or County taxes.  The taxes are deductible by the home buyer on the date of the sale of the home.  This will be listed as an itemized deduction on Schedule A.

A common misconception is that Condominium fees and Home Owner’s Association fees are a valid tax deduction; they are not.  Assessments and HOA/Condo fees are not tax deductible for a main home.

The next important section of the HUD-1 is on the second page and is found in section 801-803.  This section lists any loan origination fees or loan discount (often called points) that a person pays in exchange for obtaining a lower interest rate on a mortgage.  Each “point” charged to obtain a loan is 1% of the loan amount.  This amount may or may not appear on the Form 1098 (Mortgage Interest Statement) that you will receive from your mortgage company at the end of the year. You will want to compare your HUD-1 Statement with your Form 1098 to make sure you capture the full amount on your Schedule A, Itemized Deduction worksheet.

Points are fully deductible on the purchase of a home in the year paid if all the following are true.

  1. The loan is secured by the taxpayer’s main home.
  2. Paying points is an established business practice in the area where the loan was made.
  3. The points paid were not more than the points generally charged in that area
  4. The taxpayer uses the cash method of accounting.
  5. The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
  6. The funds the taxpayer paid at closing, plus any seller paid points, were at least as much as the points charged.  The funds paid do not have to have been applied to the points. The funds paid can include a down payment, an escrow deposit, earnest money, etc.  The funds cannot have been borrowed from the lender or mortgage broker.
  7. The loan is used to buy or build the taxpayer’s main home (not a second home).
  8. The points were computed as a percentage of the principal amount of the mortgage.
  9. The points are clearly shown on the settlement statement as points charged for the mortgage.

IF ALL OF THE ABOVE ARE MET, THE TAXPAYER CAN CHOOSE TO EITHER FULLY DEDUCT THE POINTS IN THE YEAR PAID OR AMORTIZE THEM OVER THE LIFE OF THE MORTGAGE.

If only tests 1 through 6 of the above are met, meaning you are not buying a home or building a new home, the taxpayer can still fully deduct points paid on both home improvement loans, home equity loans, and on “cash-out” refinancing loans used to substantially improve the taxpayer’s main home.

If proceeds from the loan are used for both improvements and other purposes, the points are then apportioned between the amounts used for each purpose and deducted accordingly.

So what do you do if you do not meet the test to deduct all of your points in the year paid?  This would apply to re-financed loans with no cash-out, the loan is not a home improvement loan and the loan is not for the purchase or to build a new house.  In this case, you would amortize the amount of points paid over the life of the loan. Some conditions do apply.

Example: You obtain a 30-year mortgage and you pay $10,000 in points to lower your interest rate. You would take a $333.33 deduction on your Schedule A for the next 30 years.

Any remaining balance of points being deducted over the life of the mortgage is deducted in full when the mortgage ends. This can happen when you sell the home, pay off early, or refinance with a new lender.

As you can see, the HUD-1 statement is indeed an important document, as it can help reduce the tax you owe.  Don’t miss out on these potential deductions!

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