The Fine Print for Deducting Points
The IRS rules for deducting purchase mortgage points are straightforward, but lengthy. You must meet each of these seven tests to deduct the points in the year you pay them.
1. Your mortgage must be used to buy or build your primary residence, and the loan must be secured by that residence. Your primary home is the one you live in most of the time. As long as it has cooking equipment, a toilet, and you can sleep in it, your main residence can be a house, a trailer, or a boat.
Points paid on a second home have to be deducted over the life of your loan.
2. Paying points must be a customary business practice in your area. And the amount can’t exceed the percentage normally charged. If most people in your area pay one or two points, you can’t pay 10 points and then deduct them.
3. Your points have to be legitimate. You can’t have your lender label other things on your settlement statement, like appraisal fees, inspection fees, title fees, attorney fees, service fees, or property taxes as “points” and deduct them.
4. You have to use the cash method of accounting. That’s when you report your income to the IRS as it comes in and report your expenses when you pay them. Almost everybody uses this method for tax accounting.
5. You must pay the points directly. That is, you can’t have borrowed the funds from your lender to pay them. Any points paid by the seller are treated as being paid directly by you.
In addition, monies you pay, such as a downpayment or earnest money deposit, are considered monies out of your pocket that cover the points so long as they’re equal to or more than points. Say you put $10,000 down and pay $1,000 in points. The downpayment exceeds the points, so your points are covered and therefore you can deduct them if you itemize. If you were to put nothing down but you paid one point, that $1,000 wouldn’t be deductible.
6. Your points have to be calculated as a percentage of your mortgage. One point is 1% of your mortgage amount, so one point on a $100,000 mortgage is $1,000.
7. The points have to show up on your settlement disclosure statement as “points.” They might be listed as loan origination points or discount points.
Tip: You can also fully deduct points you pay (for the year paid) on a loan to improve your main home if you meet tests one through five above. 9Houselogic 11/17/14)