Deductibility of Mortgage Points

A "point" is a fee—equal to 1% of the loan amount—that the mortgage lender charges up front. If the charge is for use of the borrowed money—as it is when the number of points charged affects the interest rate on the mortgage—rather than for loan-processing costs, the point is considered prepaid interest. As long as the home you build or buy is your principal residence, these points are fully deductible in the year paid.

Assume, for example, that to get a $100,000 mortgage you have to pay the lender three points, or an amount equal to 3% of the loan amount. You can write off that $3,000 on the tax return for the year of the purchase. Schedule A provides a special line for the deduction. The deduction effectively serves as a rebate of part of the mortgage costs. In the 28% bracket, $3,000 in points translates into $840 in tax savings. (Different rules apply to points you pay when you refinance the mortgage on your principal residence.)

A standard piece of advice, in the past, was to write a separate check to pay the points, as proof that the expense wasn't rolled into the mortgage. That was critical because if the points were included in the mortgage amount, you were using borrowed money and therefore were blocked from deducting the full expense right away. But a separate check is no longer necessary. Here's what the IRS now looks for: ■ Points paid must be in line with area norms.

■ The charge must be based on a percentage of the loan amount and it must be clearly labeled on the settlement statement as points, discount points or loan origination fee, for example.

■ By closing, you must provide at least enough cash to cover the points. This can include your down payment, escrow deposits or earnest money.

If you make a $20,000 down payment, for example, you can actually roll points into the mortgage amount and still deduct the points in the year you buy the house. The IRS will assume that points were paid with part of the down payment, rather than with the money you borrowed. You'll get a statement from the lender (IRS Form 1098) showing how much you paid in points to buy your home.

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