Are Mortgage Points Tax Deductible? Mortgage points, also known as discount points, are upfront fees paid to a lender in exchange for a reduced interest rate on your mortgage. But are these points tax deductible? The answer is often yes but with some important caveats. This comprehensive guide will delve into the intricacies of deducting mortgage points, ensuring you maximize your potential tax benefits.
What are Mortgage Points?
Before diving into deductibility, let’s clarify what mortgage points are. One point equals 1% of the loan amount. For instance, on a $200,000 mortgage, one point would be $2,000. By paying points upfront, you effectively prepay some of the interest on your loan, resulting in lower monthly payments over the life of the mortgage.
There are two main types of points:
- Origination Points: These cover the lender’s administrative costs for loan processing.
- Discount Points: These directly buy down your interest rate.
The distinction is less important for tax purposes than whether the points meet specific IRS criteria.
When is Mortgage Points Tax Deductible?
The IRS allows you to deduct mortgage points as home mortgage interest under certain conditions. Here’s a breakdown of the key requirements:
- The mortgage must be used to buy, build, or substantially improve your main home. This means the home where you live most of the time. Refinancing points are generally deductible, but the rules are different (more on this later).
- The points must be paid directly by you. You can’t borrow the money to pay the points. However, if the seller pays the points on your behalf, you’re treated as having paid them.
- The points must be customary for your area. The amount you pay should align with what other lenders in your region typically charge.
- The points must be calculated as a percentage of the loan amount.
- You must use the cash method of accounting. This is how most individual taxpayers file.
- Your settlement statement must clearly state the points (Form 1098).
Eligibility Requirements for Deduction
To deduct mortgage points in the year you pay them, you must meet all of the following requirements set by the IRS:
- Loan Secured by Your Main Home: The loan must be secured by your primary residence, meaning the home where you live most of the time. This can include a house, apartment, condominium, cooperative, mobile home, or houseboat.
- Payment Directly From Borrower’s Funds: The points must be paid directly by you, the borrower. You cannot have borrowed the funds to pay for the points from the mortgage lender or broker.
- Established Business Practice: Paying points must be an established business practice in the area where the loan was made. This means that it’s a common and accepted practice for lenders in your area to charge points.
- Points Paid Are Reasonable: The points paid must be reasonable for the amount typically charged in that area. The IRS may scrutinize excessive amounts.
- Cash Method of Accounting: You must use the cash method of accounting for tax purposes. This means you report income in the year you receive it and deduct expenses in the year you pay it.
- Points Not Paid for Other Costs: The points cannot be paid for other costs associated with buying the home, such as appraisal fees, inspection fees, title fees, or property taxes. They must be solely for reducing your interest rate.
- Home Purchase or Improvement: The points must be paid in connection with a loan to buy, build, or substantially improve your primary residence. This means the loan must be used to:
- Buy your main home
- Build your main home
- Substantially improve your main home (e.g., renovations, additions)
How to Deduct Mortgage Points
If you meet all the criteria, you can deduct the full number of eligible points in the year you paid them. Here’s how:
- Receive Form 1098: Your lender will send you this form, which reports the amount of mortgage interest and points you paid during the year.
- Itemize Deductions: You’ll need to itemize deductions on Schedule A (Form 1040) to claim the deduction. This means forgoing the standard deduction. Consider whether itemizing makes sense for your overall tax situation.
- Report on Schedule A: Enter the deductible points on the appropriate line of Schedule A.
Refinancing Points
When you refinance a mortgage, the rules for deducting points change. Instead of deducting them all in one year, you generally deduct them over the life of the new loan. For example, if you pay $3,000 in points on a 30-year refinance, you would deduct $100 per year ($3,000 / 30 years).
However, there’s an exception: If you use part of the refinanced loan to improve your home, you can deduct the portion of the points related to the improvements in the year you pay them.
Points Paid by the Seller
If the seller pays points on your behalf, you can still deduct them as if you paid them yourself. This is a common practice in some real estate transactions.
What if You Sell Your Home?
If you sell your home before fully deducting refinancing points, you can deduct the remaining balance in the year of the sale.
Record Keeping is Crucial
Keep meticulous records of all mortgage-related documents, including your settlement statement (Form 1098), loan agreements, and any records of home improvements. These documents will be essential if you need to substantiate your deduction to the IRS.
Consult a Tax Professional
While this guide provides a comprehensive overview, tax laws can be complex. Consulting a qualified tax professional is always recommended to ensure you’re maximizing your deductions and complying with all IRS regulations. They can provide personalized advice based on your specific circumstances.
Frequently Asked Questions
Can I deduct points on a refinanced mortgage?
Generally, no. Points paid on a refinanced mortgage are typically not deductible in the year paid. They must be deducted over the life of the loan.
What if I paid points to reduce my interest rate on a home equity loan?
Points paid on a home equity loan are generally not deductible unless the loan proceeds are used to buy, build, or substantially improve your primary residence.
Are there any other costs associated with a mortgage that are tax-deductible?
Yes, you can generally deduct mortgage interest payments on your primary residence.