- Escrow accounts are used to pay property taxes. However, you are not allowed to deduct payments made into your escrow account. Although money in your escrow will be used to pay property taxes, your property tax payments are not issued until the bank draws down your escrow account. Since payments into your escrow are not analogous to submitting payment for property taxes, the escrow collection at closing cannot be deducted.
- While the money used to establish an escrow account at closing is not deductible, some monies collected at closing for tax payments are deductible. If the seller has already paid the bill for the upcoming tax year, you will need to reimburse the seller for the portion of the year that you will reside in the home. At closing, money is often exchanged between the buyer and seller to account for this scenario. This transfer is known as a pro-rated tax payment and it is fully deductible.
- After closing, it may take several weeks for your mortgage company to establish an account in its banking system, set up your escrow account and begin processing transactions out of your escrow. If property taxes are due shortly after your closing, a title company will collect to pay taxes at closing so that the payment isn't missed as a result of loan setup. These funds will not go into your escrow account, but directly from the title to the taxing authority making the payment deductible.
- Aside from property taxes, certain interest costs paid at closing are deductible. You may deduct points that you have paid for a lower interest rate, although subject to some limitations. Also deductible are any early loan payment penalties charged from your former mortgage lender when you refinance. Your first interest payment is made at closing to pay for the remainder of current month. This pro-rated interest payment can be deducted since it is a payment for mortgage interest.
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