Are Mortgage Points Tax Deductible?

August 5, 2009

tax

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

Mortgage points, sometimes known as loan origination fees or discount points, can be tax deductible if certain conditions put forth by the IRS are met.

Can You Deduct Mortgage Points In Full or Over Time?

  • You have to meet a series of “tests” from the IRS
  • In order to deduct your mortgage points in full
  • For the tax year you paid them
  • Otherwise the deduction needs to be amortized over the life of the loan

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.

For example, if you paid $5,000 in points on a 30-year fixed loan, you’d generally have to amortize the tax break over 360 months.

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That works out to roughly $167 per year, or $13.89 per month, and probably isn’t enough to get excited about. And you need to itemize to take advantage of the tax break.

Fortunately, there are exceptions to deduct all the points in the tax year paid so you can potentially get a bigger refund or lower tax liability.

Let’s discuss what needs to happen in order to deduct the full amount of points paid in a single tax year.

Note: You should receive a form 1098 in the mail from your lender and/or loan originator that details any deductible points you paid during the tax year.

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

1.    Your home loan is secured by your main home

By this they mean your principal residence, where you spend the most of your time throughout the year, assuming you own multiple properties.

2.    Paying points is an established practice where the loan was made

This is pretty standard on U.S. mortgages that nearly always require points to be paid unless it’s a no cost mortgage where you get a credit.

3.    The points paid were not more than what is generally charged

Again, pretty vague and standard and mortgage lenders are now mostly restricted to charging defined amounts anyway.

4.    You use the cash method of accounting to file your taxes

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 when filing their taxes.

5.    The points were not paid in place of typical closing costs

Typically, you’ll see closing costs separated out like on the settlement statement such as home appraisal fees, inspection fees, title and escrow fees, attorney fees, lender fees, and so forth. If the lender covered all these fees with points via a lender credit, it will likely be a no-go.

6.    The funds you provided at/before closing, plus any points the seller paid, were at least as much as the points charged

The funds you provided at/before didn’t have to apply to the points, and can include things like the down payment, an escrow deposit for property taxes and homeowners insurance, earnest money, etc.

But you cannot have borrowed these funds from your mortgage lender or mortgage broker. In other words, you can’t get a tax deduction on a cost you didn’t actually bear.

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

Pretty straightforward here – the points must have been used for a home purchase loan or home improvement loan.

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 and look for that percentage on the settlement statement. Sometimes lenders just charge a flat fee and that may not be reported as deductible.

9.    Amount is clearly shown on settlement statement as points charged for the mortgage

Note that the mortgage points may be shown as paid by you or via the seller’s funds.

Assuming you meet all these requirements, which isn’t too hard to manage, despite it looking like quite 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?

  • These points need to be deducted ratably
  • Meaning proportionately throughout the loan term
  • Which will equate to a much smaller deduction each year
  • And conditions must still be met…

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 also be paid ratably.  But certain conditions must still be met in order to write off these points.

1. Must use the cash method of accounting

Same requirement we saw above for deducting points in single year.

2. Mortgage must be secured by a home

This is a more flexible requirement. For example, it can be a second home.

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

This rule shouldn’t affect too many homeowners since most have 30-year terms or less.

4. If term greater than 10 years, terms must be the same as other loans offered in your area

Basically just saying the terms of the loan should be similar to those of other home loans, which again should be pretty standard.

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
– 6 (six) if your loan term is longer than 15 years

I certainly hope your points aren’t that high and they probably won’t be! So again, shouldn’t be an issue here either.

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

  • Assuming you were deducting mortgage points ratably
  • You might be able to deduct the full, remaining amount
  • When you prepay, sell or refinance
  • But certain restrictions apply

If the mortgage ends early due to a prepayment, refinancing, or foreclosure, you can deduct the remaining amount of the points in the year the mortgage expires.

But if you refinance your home loan with the same lender, the remaining 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 certain closing costs such as appraisal fees, title and escrow fees, homeowners insurance, 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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