15.8 “Points”

Lenders sometimes charge “points” in addition to the stated interest rate. The points increase the lender’s upfront fees, but in return borrowers generally are charged a lower interest rate over the loan term. Points are either treated as a type of prepaid interest (15.14) or as a nondeductible service fee, depending on what the charge covers. If the points qualify as interest, they are deductible over the term of the loan unless they are paid on the purchase or improvement of your principal residence, in which case they are deductible in the year they are paid, as discussed below. If you pay points on a loan to purchase or improve a second home, you must deduct the points ratably over the term of the loan.

Caution

Service Fees Are Not Deductible Points

You may not deduct as points amounts that are for specific lender services. To be deductible, points on the purchase of a principal residence must be prepaid interest for the use of the loan money.

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Points are treated as interest if your payment is solely for your use of the money and is not for specific services performed by the lender that are separately charged. Whether a payment is called “points” or a “loan origination fee” does not affect its deductibility if it is actually a charge for the use of money. The purpose of the charge—that is, for the use of the money or the services rendered—will be controlling. For example, you may not deduct points that are fees for services, such as appraisal fees, preparation of a mortgage note or deed of trust, settlement fees, notary fees, abstract fees, commissions, and recording fees.

If you are selling property and you assume the buyer’s liability for points, do not deduct the payment as interest but include it as a selling expense that reduces the amount realized on the sale.

Deduction for Points on Purchase or Improvement of Principal Residence

Points are generally treated as prepaid interest (15.14) that must be deducted over the period of the loan. However, there is an exception for points you pay on a loan to buy, build, or improve your principal residence. The points on such loans are deductible in the year paid if these tests are met: (1) the loan is secured by your principal residence; (2) the charging of points is an established business practice in the geographic area in which the loan is made; (3) the points charged do not exceed the points generally charged in the area; (4) the amount of points is computed as a percentage of the loan and specifically earmarked on the loan closing statement as “points,” “loan origination fees,” or “loan discount” and (5) you pay the points directly to the lender; see “Points withheld from the principal,” below.

Filing Tip

Amortize Points Starting in Second Year

A married couple purchased a principal residence and paid points late in the year. For the year of the purchase, their standard deduction exceeded their itemized deductions. The IRS ruled that claiming the standard deduction for the year the points are paid would not entirely forfeit the deduction for points. The points may be amortized starting in the second year. Assuming that they itemize deductions starting in the second year, the allocable portion of the points may be deducted each year over the remaining loan term.

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Points paid by seller are deductible by buyer.

The seller’s payment is treated as an adjustment to the purchase price that the seller gives to you as the buyer and that you then turn over to the lender to pay off the points. You may fully deduct the points in the year paid if you meet the tests in the preceding paragraph. Otherwise, deduct them over the term of the loan. You must reduce your cost basis for the home by the seller-paid points.

Points withheld from the principal.

Points withheld from the principal of a loan used to buy, build, or improve your principal residence are deductible as if you paid them directly to the lender if, at or before closing, you have made a down payment, escrow deposit, or earnest money payment that is at least equal to the amount of points withheld. These payments must have been from your own funds and not from funds that have been borrowed from the lender as part of the overall transaction.

Points on second home.

If you pay points on a mortgage secured by a second home or a vacation home, the points are not fully deductible in the year of payment; you must claim the deduction ratably over the loan term.

Caution

Points Reported to the IRS

Points you paid in 2012 on the purchase of your principal residence will be reported to the IRS by the lender on Form 1098 if they meet the five tests for a deduction listed in 15.8. Seller-paid points are also included on Form 1098. Form 1098 is used by the IRS to check on the deduction you claim for points on Line 10 of Schedule A. Points paid on an improvement loan for your principal residence are deductible on Line 12 of Schedule A if they meet the tests; they are not shown on Form 1098.

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Points paid on refinancing.

The IRS does not allow a current deduction for points on a refinanced mortgage (15.7).

Deduct balance of points if mortgage ends early.

If you are deducting points over the term of the loan because a full first-year deduction is not allowed, you are allowed to deduct the balance in the year the mortgage ends, such as when you prepay the loan, or the lender forecloses. If the mortgage ends early because you refinance the mortgage with a different lender, you may deduct the balance of the points. For example, if you refinanced your mortgage in 2005 and paid points, those points had to be amortized over the loan term (15.7). If in 2012 you refinance again with a different lender and pay points again, the balance of the points from the 2005 loan are deductible on your 2012 return, and the points on the new loan must be amortized over the loan term. If you refinanced with the same lender, the balance of the points from the 2005 loan must be deducted over the term of the new loan.