Are Discount Points Tax Deductible?

Discount points, often known as “points,” are fees paid directly to a lender at closing in exchange for a lower interest rate on a mortgage. One point typically equals one percent of the mortgage loan amount. For example, on a $300,000 loan, one point would be $3,000. These upfront payments represent prepaid interest, allowing borrowers to reduce their monthly mortgage payments. Understanding the tax implications of these points can lead to potential tax savings.

Discount points can be tax deductible under specific conditions, primarily when treated as home mortgage interest. This deductibility is not automatic and depends on the loan’s purpose and how the points were paid. The Internal Revenue Service (IRS) outlines criteria taxpayers must meet to claim this deduction.

Fundamental Requirements for Deductibility

To be deductible, discount points must meet several conditions. The loan must be secured by your main home, the residence you ordinarily live in most of the time. This ensures the deduction applies to primary residences, not investment properties or second homes.

Points must be for the use of money, not for services or other fees like appraisal or title charges. Only amounts calculated as a percentage of the principal mortgage amount qualify.

Points must be an established business practice in the loan’s area and not exceed amounts generally charged for similar loans. This ensures they reflect a genuine interest rate reduction.

The amount of points paid must be clearly shown on the settlement statement, such as a Form HUD-1 or a Closing Disclosure. This documentation is important for substantiating the deduction. Taxpayers must use the cash method of accounting, reporting income when received and deducting expenses when paid.

The points must actually be paid by the buyer from funds not borrowed as part of the mortgage. These funds must come from sources like a down payment, escrow deposits, or earnest money. If funds to pay points are directly borrowed from the lender, they are generally not deductible in the year paid.

Deductibility in Different Loan Situations

The deductibility of discount points varies based on the type and purpose of the mortgage loan. Points paid on a loan to purchase or build your main home are generally fully deductible in the year paid, provided all fundamental requirements are met. This offers an immediate tax benefit.

Points paid on a refinance loan are typically not fully deductible in the year paid. Instead, they must be amortized, deducted equally over the loan’s life. For example, $3,600 in points on a 30-year refinance mortgage means a $10 monthly deduction, totaling $120 per year. This deduction continues for each payment made during the tax year. If the refinanced mortgage ends early, any remaining unamortized points can be deducted in that year.

For home equity loans or lines of credit (HELOCs), points are generally amortized over the loan’s life. Interest on these loans, including amortized points, is only deductible if the loan proceeds are used to buy, build, or substantially improve the home. For tax years 2018 through 2025, limits apply to home mortgage interest deductions, including points, for indebtedness exceeding $750,000 ($375,000 if married filing separately).

If the seller pays points on behalf of the buyer, the buyer can generally deduct them. However, the buyer must subtract these seller-paid points from the home’s basis (its cost for tax purposes). This adjustment affects future gain calculations when the home is sold.

Claiming the Deduction

To claim the deduction for eligible discount points, taxpayers must itemize their deductions on Schedule A (Form 1040), “Itemized Deductions.” Form 1098, “Mortgage Interest Statement,” typically provides the necessary information. Lenders are required to issue Form 1098 if they receive $600 or more in mortgage interest or points during the year.

On Form 1098, Box 6 reports points paid for a principal residence, which can be transferred to Schedule A (Form 1040). If points are not in Box 6, they can be reported on a separate line on Schedule A.

For amortized points, such as those from a refinance loan, taxpayers must track the deduction over multiple years. The total points are divided by the number of payments over the loan’s term, and the deductible portion for each year is claimed. Taxpayers should maintain a detailed record of the amortization schedule to ensure accurate annual deductions.

Maintaining thorough records is important for substantiating any claimed deduction. This includes keeping the Closing Disclosure (or HUD-1 statement), which clearly shows the points paid, and all Forms 1098 received from the lender. These documents provide proof of payment and compliance with IRS requirements, important in the event of an audit.