Points on a home loan are usually deducted over the life of the loan, but the IRS describes a case where they may be deducted in the year you pay them, in its Topic no. 504.
The default
The IRS describes points, also called loan discount or discount points, as a form of prepaid interest. Each point paid lowers the interest rate on the monthly payments. In general, points to obtain a new mortgage, to refinance, or on a loan secured by a second home are deducted ratably over the term of the loan.
When the year you pay them may apply
If you itemize deductions on Schedule A, points that meet certain criteria may be deductible as home mortgage interest. The IRS says you can deduct the points to obtain a mortgage on your principal residence in the year you pay them if you use the cash method of accounting. The points must relate to a mortgage to buy, build or improve your principal residence, and that home must secure the mortgage. Paying points must be an established business practice in the area where the loan was made, and the points can’t be more than the amount generally charged there.
Funds and paperwork
You provide funds at or before closing at least equal to the points charged, and you can’t use funds borrowed from your lender or mortgage broker. Seller-paid points are treated as paid directly by you if you subtract the amount from your basis in the home. The points must be computed as a percentage of the principal amount and show clearly as points on your settlement statement.
What isn’t interest
The IRS says costs to prepare a mortgage note, appraisal fees and notary fees aren’t deductible as interest. A seller can’t deduct points paid for your loan, but they reduce the seller’s gain on the sale.
Who to ask
A tax adviser can say what applies to a specific purchase.
Questions
Common questions
Can I deduct mortgage points the year I pay them?
The IRS says you can deduct points to obtain a mortgage on your principal residence in the year you pay them if you itemize, use the cash method of accounting, and meet the other items on its list.
How are points normally deducted?
The IRS says that in general, points to obtain a new mortgage, to refinance, or on a second home are deducted ratably over the term of the loan.
Can I deduct points the seller paid for my loan?
The IRS says seller-paid points are treated as paid directly by you from unborrowed funds if you subtract the amount from your basis in the home. The seller can't deduct them, but they reduce the seller's gain.
Written by Diana Yeji Kim — REALTOR® at eXp Realty, serving Greater Boston in English, Korean, and Japanese.
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