When you first purchased your home, you may have paid points to lower the interest rate on your mortgage. While you knew that it would save you a lot of money over time, you probably didn't realize those same points could save you some money right away.
Under certain circumstances, this pre-paid interest can be deducted from taxes, but many homeowners often overlook this benefit. Of course, the guidelines are complicated so it's always a good idea to check with your tax advisor before filing.
The Nine Criteria: IRS Guidelines for Mortgage Point Tax Deductions
Mortgage points can be deducted fully or over the life of a loan. Typically, most homeowners must amortize their deductions over the loan term. But, if you meet the Internal Revenue Service's following nine criteria, you may be eligible for a full deduction in the year of payment and a greater tax break:
- The loan must be secured by your main home.
- Paying points is an established business practice in your area.
- The points are generally what are charged in your region.
- You use the cash method of accounting, meaning you record income in the year you receive it and deduct expenses in the year you pay them.
- The points are not paid in place of amounts ordinarily stated separately on the settlement sheet. That is, you cannot pay points in exchange for appraisal fees, inspection fees, title fess, attorney fees and property taxes.
- The funds you come up with at or before closing, plus any points the seller pays, must be at least as much as the points charged. In addition, you cannot have borrowed any of the settlement money from your lender, mortgage broker or bank.
- The loan is used to buy or build your main home.
- The points are computed as a percentage of your mortgage's principal amount.
- The amount is clearly shown on the settlement statement as points charged for the mortgage. The points may be shown as paid from either buyer or seller funds.
Just keep in mind - these criteria only apply to costs associated with your primary residence. Points paid to purchase a second or vacation home must be amortized over the life of the loan.
Refinance Point Tax Deductions
For those who have chosen to refinance, the IRS states that all associated points must be deducted over the life of the loan. However, if any portion of those refinance points is used towards home improvements and meets criteria one through six (as listed above), those points may be fully deductible in the year paid. The remaining refinance points, however, will not qualify for an immediate tax deduction. Rather, this leftover balance must be deducted over the life of the loan. This same tax rule also applies towards home equity lines of credit and home equity loans.
Words of Wisdom
To ensure you reap the full rewards of your mortgage point tax break, make sure to consult your tax advisor and file with precision.
For more information regarding the deduction of mortgage points, please visit the Internal Revenue Service's Home Mortgage Interest Deduction page.