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.
Are My Points Fully Deductible This Year?
A borrower is treated as paying any points that a home seller pays for the borrower's mortgage. See Points paid by the seller, later.
General rule. You cannot deduct the full amount of points in the year paid. Because they are prepaid interest, you must spread the points over the life (term) of the mortgage. Generally, you can deduct an equal portion in each year of the mortgage.
Exception. You can deduct in 1997 the entire amount paid on your loan as points if all the following are true.
Home improvement loan. You can deduct in 1997 the entire amount of points paid on a loan to improve our main home, if statements (1) through (5) above are true.
Figure B. You can use Figure B as a quick check to see if points are fully deductible in the year paid.
Amounts charged for services. Amounts charged by the lender for specific services connected to the loan are not interest. Examples are appraisal fees, notary fees, and preparation costs for the mortgage note or deed of trust. You cannot deduct these amounts as points either in the year paid or over the life of the mortgage. For information about the tax treatment of these amounts and other settlement fees and closing costs, get Publication 530, Tax Information for First-Time Homeowners.
However, an amount shown on your settlement statement as points may be deductible in the year paid under the Exception to the General rule, even if it is for services in connection with your mortgage (whether VA, FHA, or conventional). The services must not be any of the specific services for which a charge ordinarily is stated separately on the settlement statement, as described in test (5) of the Exception. The other tests under the Exception also must be met.
Points paid by the seller. The term "points" includes loan placement fees that the seller pays to the lender to arrange financing for the buyer.
Treatment by seller. The seller cannot deduct these fees as interest. But they are a selling expense that reduces the seller's amount realized.
Treatment by buyer. 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 under the Exception are met, the buyer deducts 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.
If you need information about the basis of your home, get Publication 523, Selling Your Home, or Publication 530.
Funds provided are less than points. If you meet all the tests in the Exception 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.
Example 1. When you took out a $100,000 mortgage loan to buy your home in December 1997, you were charged one point ($1,000). You meet all the nine tests for deducting points in the year paid, except the only funds you provided were a $750 down payment. Of the $1,000 charged for points, you can deduct $750 in 1997.
Example 2. The facts are the same as in Example 1, except that the person who sold you your home also paid one point ($1,000) to help you get your mortgage. In 1997, you can deduct $1,750 ($750 of the amount you were charged plus the $1,000 paid by the seller). You must reduce the basis of your home by the $1,000 paid by the seller.
Excess points. If you meet all the tests in the Exception except that the points paid were more than generally paid in your area (test 3), your deduction in 1997 is limited to the points generally charged. Any additional amount of points paid is interest paid in advance, and you must spread the deduction over the life of the mortgage.
Second home. The Exception 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 ending 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. A mortgage may end early due to a prepayment, refinancing, foreclosure, or similar event.
Example. Dan refinanced his mortgage in 1992 and paid $3,000 in points that he had to spread out over the life of the mortgage. He had deducted $1,000 of these points through 1996.
Dan prepaid his mortgage in full in 1997. He can deduct the remaining $2,000 of points in 1997.
Refinancing. Generally, points you pay to refinance a mortgage are not deductible in full in the year you pay them. This is true even if the new mortgage is secured by your main home.
However, if you use part of the refinanced mortgage proceeds to improve your main home and you meet the first five tests listed under the Exception, 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.
Example 1. In 1991, Bill Fields got a mortgage to buy a home. The interest rate on that mortgage loan was 11%. In 1997, Bill refinanced that mortgage with a 15-year $100,000 mortgage loan that has an interest rate of 8%. 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. Bill 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. Bill's first payment on the new loan was due July 1. He made six payments on the loan in 1997 and is a cash basis taxpayer.
Bill used the funds from the new mortgage to repay his existing mortgage. Although the new mortgage loan was for Bill's continued ownership of his main home, it was not for the purchase or improvement of that home. For that reason, Bill does not meet all the tests in the Exception, and he cannot deduct all of the points in 1997. He can deduct two points ($2,000) ratably over the life of the loan. He deducts $67 (($2,000 ≈ 180 months) ╫ 6 payments) of the points on his 1997 Form 1040 (on line 12, Schedule A). The other point ($1,000) was a fee for services and not deductible.
Example 2. The facts are the same as in Example 1, except that Bill used $25,000 of the loan proceeds to improve his home and $75,000 to repay his existing mortgage. Bill deducts 25% ($25,000 ≈ $100,000) of the $2,000 prepaid interest in 1997. His deduction is $500 ($2,000 ╫ 25%).
Additionally, in 1997, Bill 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) ╫ 6 payments). The total amount deductible in 1997, on line 12, Schedule A, is $550 ($500 + $50).
Limits on deduction. You cannot fully deduct points paid on a mortgage that exceeds the limits discussed in Part II. See the Table 1 Instructions for line 10 in Part II.
Form 1098. The mortgage interest statement you receive should show not only the total interest paid during the year, but also your deductible points. See Mortgage Interest Statement, next.