Tax Tip: Lock in Mortgage Interest Deductions for Points

By Ken Berry
 
This is the second article in our series of tax return tips for 2011 returns. 
 
Although mortgage interest rates are at historic lows, it may be possible to obtain an even more favorable rate by agreeing to pay one or more "points" to the lender. What are the tax implications? The IRS says that points are currently deductible as "qualified residence interest" if the following nine requirements are met:

Note that points paid in connection with a vacation home aren't deductible, even if the taxpayer is entitled to mortgage interest deductions for that home.
  1. The loan is secured by the taxpayer's principal residence.
  2. Paying points is an established business practice in the area.
  3. The points are generally equal to the amount being charged in the area.
  4. The taxpayer uses the cash method of accounting.
  5. The points aren't being paid as a substitute for other amounts on the settlement sheet (e.g., appraisal fees, inspection fees, title fees, attorney fees, or property taxes).
  6. The amount of the down payment (plus any seller-paid points) is at least as much as the amount of points charged.
  7. The loan is used to buy or build the taxpayer's principal residence.
  8. The points are computed as a percentage of the mortgage principal.
  9. The points are stated on the settlement sheet as being paid by the buyer or the seller.
Note that points paid in connection with a vacation home aren't deductible, even if the taxpayer is entitled to mortgage interest deductions for that home.
 
What happens if a taxpayer pays points on a refinanced loan? In that case, the points must be amortized over the life of the new loan. For example, suppose your client paid one point in 2011 to refinance down a ten-year mortgage of $200,000, or $2,000. Beginning with the 2011 return, the client can deduct $200 each year for the next ten years.
 
Finally, if a client takes out a loan or home equity line of credit for home improvements, the points attributable to those improvements are deductible in full. Any remainder is amortized over the life of the loan.


See the whole series of Ken Berry's tax tips for the 2012 filing season
  1. How to Secure an 'Extra' Dependency Exemption
  2. Choose the 'Biggest and Best' State Tax Deduction
  3. Lock in Mortgage Interest Deductions for Points
  4. Generate Energy Credits for Clients
  5. Dish Out Tax Rewards to Charitable Volunteers
  6. A Party at Home? That's (Deductible) Entertainment!
  7. Spell Out Tax Rules for Business Education
  8. Add on Medical Expenses for a Nondependent
  9. How Do You Spell Tax Relief? C-a-s-u-a-l-t-y Loss
  10. Expand the Reach of Dependent Care Credit

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