Tax Tips
Are Points Paid for a Mortgage Deductible? - January 2003
Richard Scrivanich - Partner
With mortgage rates the lowest they've been in 35 years, many homeowners are considering the possibility of refinancing their mortgage. Whether you are refinancing an existing mortgage or purchasing a new home, it is important to consider the tax treatment of the various fees that you may incur. The tax treatment of points may be perhaps the most confusing.
What are points?
The term points is used to describe certain charges paid to obtain a home mortgage. They are also referred to as loan origination fees or premium charges. If the payment of any of these charges is only for the use of money, it is considered interest. Although mortgage interest is generally deductible, the tax treatment of points depends on the use of the loan proceeds and other issues.
If you are purchasing a home
If the loan is used to purchase your principal home, the charges for points are deductible in full in the year paid, whether paid out of separate funds or (if certain conditions are met) incorporated into the mortgage note. These conditions are:
- Your lender prepares a Form HUD-1, Uniform Settlement Statement, that explicitly states the points incurred on the loan. Points may be identified as "loan origination fees," "loan discount," "discount points," or simply, "points";
- The points must be computed as a percentage of the principal amount of the loan; and
- The total of your down payment plus other cash paid by the time you close must be at least as much as the amount of points charged.
Points on a second home
Points paid on a loan to purchase or improve your second home do not qualify for full, immediate deduction, since the loan does not relate to your principal residence. They must be spread out (amortized) over the life of the loan.
Points paid in connection with a refinancing
The rules pertaining to points incurred in the purchase of a home apply in the case of a refinancing as well. However, there are additional rules that depend on the use of the proceeds. To the extent the proceeds are used to repay the old mortgage, the points must be amortized over the life of the new mortgage. If a portion of the proceeds is used to make improvements to the home, the points are deductible in the same proportion as the portion of the proceeds of the new mortgage used to make the improvements. There are certain limitations which may affect the deductibility of the points, including the $100,000 limit on home equity indebtedness and the $1,000,000 limit on home acquisition indebtedness.
What about points from an old mortgage that are currently being amortized? If you have been deducting points each year, the unamortized balance may be written off in the year the old mortgage is refinanced.
What if the seller pays the points?
Sellers sometimes agree to pay the points on a buyer's mortgage loan. If this is the case, you can deduct the points in the year you acquire the home. However, your tax basis in your home is reduced by the amount of the seller-paid points. There are some limitations on the deductibility of seller-paid points, and we would be happy to review these with you if you are considering this type of arrangement.
The bottom line
The tax treatment of the points you pay may influence your decision about which financing arrangement is best for you. Although current interest rates may give you a better bottom line, making a tax-smart decision will make it even better.
If you have any questions about this article, or any other tax matter, please feel free to give me a call at (562) 698-9891.
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