This Financial Guide explains when and to what extent points paid on the purchase of a home or on a refinancing are deductible. It explains the rules for deducting points and discusses special circumstances and situations.
What Are Points?
The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Points may also be called loan origination fees, maximum loan charges, loan discount, or discount points.
Points are prepaid interest and may be deductible as home mortgage interest if you itemize deductions on Form 1040, Schedule A. Generally, if you can deduct all of the interest on your mortgage, you may be able to deduct all of the points paid on the mortgage. If your acquisition debt exceeds $1 million or your home equity debt exceeds $100,000, you cannot deduct all the interest on your mortgage and you cannot deduct all your points.
One important point to note is that a borrower is treated as paying any points that a home seller pays on his or her behalf to obtain the mortgage.
Generally, the borrower cannot deduct the full amount of points in the year paid. Because they are prepaid interest, the borrower generally is required to deduct them over the life (term) of the mortgage.
However, the borrower can fully deduct points in the year paid if all of the following tests are applicable:
Home improvement loan. You can also fully deduct in the year paid points paid on a loan to improve your main home if statements (1) through (5) above are true.
You cannot deduct amounts charged by the lender for specific services connected to the loan that are not considered to be interest. These amounts cannot be deducted in the year paid or over the life of the mortgage. Examples of these charges are:
Points Paid by Seller
The term “points” includes loan placement fees that the seller pays to the lender on behalf of the buyer to secure the financing arrangement. The seller cannot deduct these fees as interest. But they are a selling expense that reduces the seller’s amount realized. The buyer reduces the basis of the home by the amount of the seller-paid points and treats the points as if he or she had paid them. If all the tests explained earlier are met, the buyer can deduct the points in the year paid. If any of those tests is not met, the buyer deducts the points over the life of the loan.
Funds Provided Are Less than Points
If you meet all the tests referred to earlier; except that the funds you provided were less than the points charged to you (test 9), you can deduct the points in the year paid, up to the amount of funds you provided. In addition, you can deduct any points paid by the seller.
A) When you took out a $ 200,000 mortgage loan to buy your home in December, you were charged one point ($2,000). You meet all the nine tests for deducting points in the year paid, except the only funds you provided were a $1750 down payment. Of the $2,000 charged for points, you can deduct $1,750 in the year paid. You spread the remaining $250 over the life of the mortgage.
B) The facts are the same as above, except that the person who sold you your home also paid one point ($2,000) to help you get your mortgage. In the year paid, you can deduct $3,750 ($1750 of the amount you were charged plus the $2,000 paid by the seller). You must reduce the basis of your home by the $2,000 paid by the seller.
If you meet all the tests except that the points paid were more than generally paid in your area (test 3), you should deduct in the year paid only the points that are generally charged. You must spread any additional points over the life of the mortgage.
Points Paid on Second Home
The general rule of instant deductibility does not apply to points you pay on loans secured by your second home. You can deduct these points only over the life of the loan.
Mortgage Ends Early
If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. However, if you refinance the mortgage with the same lender, you cannot deduct any remaining balance of spread points. Instead, deduct the remaining balance over the term of the new loan.
A mortgage may end early due to a prepayment, refinancing, foreclosure, or any similar event.
A) Joan paid $3,000 in points in 2006 that she had to spread out over the 15-year life of the mortgage. She had deducted $1,200 of these points through 2011. Joan prepaid her mortgage in full in 2012. She can deduct the remaining $1,800 of points in 2012.
Points Paid on Refinancing
Even in the case of a refinancing and the mortgage is secure by your main home, generally, points you pay to refinance a mortgage are not deductible in full in the year you pay them.
However, if you use part of the refinanced mortgage proceeds to improve your main home and you meet the first five tests listed earlier; you can fully deduct the part of the points related to the improvement in the year paid. You can deduct the rest of the points over the life of the loan.
A) In 1999, Joe Gibbs got a mortgage to buy a home. The interest rate on that mortgage loan was 11 percent. In 2008, Joe refinanced that mortgage with a 15-year $100,000 mortgage loan that has an interest rate of 7 percent. The mortgage is secured by his home. To get the new loan, he had to pay three points ($3,000). Two points ($2,000) were for prepaid interest, and one point ($1,000) was charged for services, in place of amounts that ordinarily are stated separately on the settlement statement. Joe paid the points out of his private funds, rather than out of the proceeds of the new loan. The payment of points is an established practice in the area and the points charged are not more than the amount generally charged there. Joe’s first payment on the new loan was due July 1. He made six payments on the loan in 2008 and is a cash basis taxpayer.
Joe used the funds from the new mortgage to repay his existing mortgage. Although the new mortgage loan was for Joe’s continued ownership of his main home, it was not for the purchase or improvement of that home. For that reason, Joe does not meet all the tests, and he cannot deduct all of the points in 2008. He can deduct two points ($2,000) ratable over the life of the loan. He deducts $67 [($2,000 ÷ 180 months) x 6 payments] of the points in 2008. The other point ($1,000) was a fee for services and is not deductible.
B) The facts are the same as above, except that Joe used $25,000 of the loan proceeds to improve his home and $75,000 to repay his existing mortgage. Joe deducts 25 percent ($25,000 ÷ $100,000) of the $2,000 prepaid interest in 2008. His deduction is $500 ($2,000 x 0.25).
Joe also deducts the ratable part of the remaining $1,500 ($2,000 – $500) prepaid interest that must be spread over the life of the loan. This is $50 [($1,500 ÷ 180 months) x 6 payments] in 2008. The total amount Joe deducts in 2008 is $550 ($500 + $50).
It is important to note also that you cannot fully deduct points paid on a mortgage that exceeds the limits on the home mortage.
The mortgage interest statement (Form 1098) you receive should show not only the total interest paid during the year but also your deductible points.
The statement will show the total interest you paid during the year. If you purchased a main home during the year, it also will show the deductible points paid during the year, including seller-paid points. However, it should not show any interest that was paid for you by a government agency.
As a general rule, Form 1098 will include only points that you can fully deduct in the year paid. However, certain points not included on Form 1098 also may be deductible, either in the year paid or over the life of the loan.
User | 4/11/2017