Are Mortgage Points Tax Deductible?

August 5, 2009 No Comments »

tax

More mortgage Q&A: “Are mortgage points tax deductible?”

Mortgage points, otherwise known as loan origination fees or discount points, are tax deductible if certain conditions are met.

Generally, you cannot deduct the full amount of mortgage points in the year paid, as they are considered prepaid interest and must be deducted equally through the life of the loan, though there are exceptions.

You can deduct the full amount of mortgage points in the year paid if ALL the following tests are met:

1.    Your loan is secured by your main home. (Generally, your main home is the one you live in most of the time.)

2.    Paying points is an established business practice in the area where the loan was made (this is pretty standard on U.S. mortgages).

3.    The points paid were not more than the points generally charged in that area (again, pretty vague and standard).

4.    You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay them. Most individuals use this method.

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 you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. The funds you provided do not have to have been applied to the points. They can include a down payment, an escrow deposit, earnest money, and other funds you paid at or before closing for any purpose. You cannot have borrowed these funds from your lender or mortgage broker.

7.    You use your loan to buy or build your main home.

8.    The points were computed as a percentage of the principal amount of the mortgage (emphasis mine, this isn’t always the case so read your loan documents carefully).

9.    The amount is clearly shown on the settlement statement (such as the Uniform Settlement Statement, Form HUD-1) as points charged for the mortgage. The points may be shown as paid from either your funds or the seller’s.

Assuming you meet all these requirements (which isn’t too hard to manage, despite it looking like a lot), the mortgage points are fully tax deductible in the year the mortgage was taken out.

What About Points That Aren’t Fully Deductible in the Year Paid?

As mentioned in the beginning of this article, not all mortgage points can be fully deducted in the year paid.  Some have to be deducted ratably, or proportionately each year for the life of the loan.

For example, if your mortgage points totaled $5,000 and you took out a 15-year fixed, you’d be able to deduct roughly $333 annually ($5,000/180 months = $27.78 x 12 months = $333).

*The first year you took out the mortgage would probably be less because you would make fewer than 12 monthly payments.

Points paid on refinance loans and points paid to buy second homes/investment properties must be paid ratably.  But certain conditions must still be met in order to write off these points.

1. You must use the cash method of accounting.

2. Your loan must be secured by a home (doesn’t have to be your main home).

3. Your loan term must not be longer than 30 years (sorry 40-year mortgage holders).

4. If your loan term is longer than 10 years, the terms of the loan must be the same as other loans offered in your area for the same or longer term.

5. Your loan amount must be $250,000 or less, or the number of points cannot be more than:

– 4 (four), if your loan term is 15 years or less, or
– 6 (six), if your loan term is longer than 15 years

As you can see, the rules are a lot less stringent if you’re simply deducting points over the full term of your mortgage.

A couple more notes though.  For home improvement loans, you can fully deduct in the year paid any points paid to improve your main home.

For refinance loans, you can fully deduct the portion of the points related to the improvement in the year you paid them, with the remainder deductible over the life of the loan.

If you happen to provide funds at closing that are less than the mortgage points, you can only deduct up to the amount of funds you provided during the year the mortgage was taken out; the rest must be spread over the life of the loan.

For example, if you paid one point ($1,000) on a $100,000 mortgage, but only came in with $750 of your own funds, you could only deduct $750 in the year the loan was taken out, with the remainder spread over the life of the loan.

You Can Deduct the Full Amount of Points When Selling or Refinancing

If the mortgage ends early due to a prepayment, refinancing, foreclosure, or a similar event, you can deduct the remaining amount in the year the mortgage expires.  But if you refinance with the same lender, points must be deducted over the life of the new loan.

If you don’t itemize your deductions in the year the loan is taken out, you can spread the mortgage points over the life of the loan and deduct in the future when you do itemize deductions.

Keep in mind that you can also deduct any mortgage points paid by the seller of the home, assuming you meet all the requirements listed above.

Note that costs such as appraisal fees, title and escrow fees, and notary fees are not interest, and are therefore not tax deductible.

As always, any tax related questions should be reviewed by a tax professional to ensure their accuracy as guidelines do change often.

(Source: IRS Publication 936)

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