Yes, the IRS allows you to deduct prepayment penalties on your tax return. You need to be able to itemize if it was not a rental.
Qualifying for the Deduction
To deduct the entire prepayment penalty in one year, you must pay the penalty in full. If you refinance and roll the penalty into your new loan, you can deduct the penalty over the life of the loan. For borrowers who refinance but choose to pay the prepayment penalty at closing, the entire penalty is deductible.
Reporting the Deduction
Typically, the prepayment penalty is equal to a percentage of the remaining interest you would pay over the course of the loan. If the loan is for your primary residence or secondary home, report the deduction on Schedule A as home-mortgage interest. If the loan is for a rental home, the interest is deducted on Schedule E. To claim the expense, you must itemize.
