Written by Marc R Barnes EA
September 26, 2009
Points, sometimes also called a "discount point", are a form of pre-paid interest. One point equals one percent of the loan amount. Points may also be called loan origination fees, maximum loan charges, or loan discount.

Are they Deductible?

Generally, you cannot deduct the full amount of points in the year paid. Because they are prepaid interest, you must deduct them over the life of the mortgage.
However, you can fully deduct points in the year paid if you meet all of the following tests.
  1. Your loan is secured by your main home (the one you live in most of the time).
  2. Paying points is an established business practice in the area where the loan was made.
  3. The points paid were not more than the points generally charged in that area.
  4. You use the cash method of accounting (the method used by most individual taxpayers).
  5. The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
  6. You use your loan to buy or build your main home.
  7. The points were computed as a percentage of the principal amount of the mortgage.
  8. The amount is clearly shown on the settlement statement (such as the Uniform Settlement Statement, Form HUD-1) as points charged for the mortgage. The points may be shown as paid from either your funds or the seller's.
  9. The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. The funds you provided do not have to have been applied to the points. They can include a down payment, an escrow deposit, earnest money, and other funds you paid at or before closing for any purpose. You cannot have borrowed these funds from your lender or mortgage broker.
Home improvement loan. You can also fully deduct in the year paid points paid on a loan to improve your main home, if statements (1) through (5) above are true.

Non-Deductible Amounts

Amounts charged by the lender for specific services connected to the loan are not interest. Examples of these charges are:
  1. Appraisal fees
  2. Notary fees
  3. Preparation costs for the mortgage note or deed of trust
  4. Mortgage insurance premiums
  5. VA funding fees.
You cannot deduct these amounts as points either in the year paid or over the life of the mortgage.

Points Paid By Seller

The term "points" includes loan placement fees that the seller pays to the lender to arrange financing for the buyer. The seller cannot deduct these fees as interest. But they are a selling expense that reduces the seller's amount realized. 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 explained earlier are met, the buyer can deduct 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.

Points Paid on Second Home

The general rule of instant deductibility 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 Ends 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. However, if you refinance the mortgage with the same lender, you cannot deduct any remaining balance of spread points. Instead, deduct the remaining balance over the term of the new loan.

A mortgage may end early due to a prepayment, refinancing, foreclosure, or similar event.
Example: Dan paid $3,000 in points in 2002 that he had to spread out over the 15-year life of the mortgage. He had deducted $1,200 of these points through 2007. Dan prepaid his mortgage in full in 2008. He can deduct the remaining $1,800 of points in 2008.

Points Paid on 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 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.
Topic: Homes