How to take the tax break on points paid for home loans

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If you paid points while taking your home loan, you can deduct the entire amount paid for such points in the year of payment.  However, you need to be careful about the conditions laid down by IRS while claiming such a deduction.

Points are charges paid by a borrower to get the Home Mortgage.  They can also be called as loan origination fees or loan discount.  If a home seller pays money for the borrower’s mortgage, it is also called payment of points by the buyer.

As the definition says, this money is paid on the loan as a whole and should be deducted over a number of years the loan is repaid.  However you can claim the entire amount of points in the year of payment if you satisfy the conditions laid down by the IRS.

  1. The loan must be secured by your main home, the home where you live in most of the time.
  2. The payment for points must be an established business practice in the area where the loan was made.
  3. The amount paid for the points should not be more than the points charged in that area in general.
  4. You should be adopting ‘cash method’ of accounting.  Many individuals use this method.  In this method you have to report your income in the year you received it and you claim expenses as deductions in the year you paid for them.
  5. The points should not be paid in respect of the amounts which are ordinarily mentioned on the settlement statement separately.  Fees like appraisal fees or inspection fees, title fees or attorney fees are mentioned specifically on the settlement statement and they should not be treated as amounts paid towards points.
  6. You should use the loan to buy or build your main home.
  7. The points should be computed as a percent of the principal amount of the mortgage.
  8. The funds you provided and the points the seller paid must be at least as much as the points charged.  So the funds you provided including a down payment, an escrow deposit, or an earnest money should not have been applied to the points.  You cannot borrow money to pay these items from your lender or mortgage broker.
  9. The amount for points charged for the mortgage must be clearly shown on the settlement statement.

If you satisfy all these conditions and if you itemize your deductions in the year you got the loan, you can deduct the full amount of points in the year of payment.

If you do not itemize your deductions in the year you get the loan, then you can spread the points over the life of the loan and deduct appropriate amounts in each future year when you itemize your deductions.

If you take a loan to improve your main home, the points paid can be fully deducted in the year of such payment.  If you use part of the refinance mortgage proceeds to improve your main home and you fulfill the above tests, then you can fully deduct the part of the points related to the improvement in the year you paid them with your own funds.  The rest of the points can be deducted over the life of the loan.

If you meet all the above tests but the funds you provided are less than the points charged to you, you can deduct the remaining balance over the life of the mortgage.

If the points paid are more than generally charged in your area, you can deduct only the points that are generally charged in the year of payment.  The additional points must be spread over the life of the mortgage.

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