Are Mortgage Points Tax Deductible?

Mortgage points are prepaid interest a borrower pays to a lender at closing on a home loan. Also known as loan origination fees or discount points, they can sometimes reduce the mortgage interest rate. Deducting these points for tax purposes depends on specific conditions related to the loan type and how the points are paid. The rules vary significantly based on whether the loan is for a home purchase, a refinance, or a home equity loan. Understanding these distinctions is important for accurately claiming any potential tax benefits.

General Conditions for Deductibility

For mortgage points to be tax deductible, they must meet several criteria. The loan must be secured by the taxpayer’s main home, where they ordinarily live. This ensures the deduction is tied to a primary residence.

Points must be an established business practice in the loan’s geographical area, and the amount charged should not exceed what is generally charged there. They must be calculated as a percentage of the loan principal and clearly indicated on the settlement statement, such as a Closing Disclosure or HUD-1 form.

The borrower must have paid the points directly from their own funds, or indirectly through funds not borrowed from the lender. If a seller pays points on behalf of the buyer, these are treated as if the buyer paid them. Finally, the loan proceeds must be used to acquire, construct, or substantially improve the main home. If the loan proceeds are not used for these specific purposes, the points are generally not deductible.

Deducting Points on Home Purchases

Points paid in connection with purchasing or constructing a main home generally qualify for a full deduction in the year they are paid. This immediate deductibility is a significant advantage for new homeowners. To qualify, the points must meet the general conditions for deductibility, including being a customary charge in the area and not excessive.

The points must be clearly itemized on the closing documents. For example, if a homebuyer pays points to obtain a mortgage for their primary residence, these points are typically fully deductible in the tax year of the purchase. This applies even if the seller pays the points; the buyer can still deduct them.

Points paid for a loan used to substantially improve a main home are also generally deductible in the year paid, provided the loan is secured by the main home and meets the other general conditions. This allows homeowners to deduct points on loans taken out for significant renovations or additions to their primary residence. The key distinction for purchase and improvement loans is the immediate recognition of the deduction, unlike with refinances.

Deducting Points on Refinances and Home Equity Loans

The rules for deducting points on refinanced mortgages and home equity loans or lines of credit (HELOCs) differ considerably from those for home purchases. Points paid on a refinance are generally not fully deductible in the year they are paid. Instead, these points must be amortized, meaning they are deducted ratably over the life of the loan.

For example, if a borrower pays points on a 30-year refinanced mortgage, the total points are divided by 360 months, and that monthly amount is deducted each year. If the refinanced loan is later paid off early, perhaps by selling the home or refinancing with a different lender, any remaining unamortized points from the original refinance can typically be deducted in the year the loan is paid off. However, if the refinance is with the same lender, the remaining points might need to be amortized over the new loan’s term.

Points paid on home equity loans or HELOCs are also typically amortized over the loan term, similar to refinance points. Interest on home equity debt, including any points, is only deductible if the loan proceeds are used to buy, build, or substantially improve the taxpayer’s main home or a second home. If the funds are used for other purposes, such as consolidating personal debt, the interest and points are not deductible.

Reporting and Claiming the Deduction

Taxpayers who qualify to deduct mortgage points will receive a Form 1098, “Mortgage Interest Statement,” from their lender. This form reports the total mortgage interest paid during the year, and in some cases, the amount of points paid. Specifically, Box 6 on Form 1098 indicates points paid for the purchase of a principal residence.

It is important to retain a copy of the closing statement, often referred to as a Closing Disclosure or HUD-1 Settlement Statement. This document provides a detailed breakdown of all charges incurred at closing, including any points paid, and serves as crucial documentation for verifying amounts reported on Form 1098. This statement can also help identify points that may not be reported in Box 6 of Form 1098, such as those for a refinance or home improvement loan.

To claim the deduction, taxpayers must itemize deductions on Schedule A (Form 1040). The deductible mortgage interest, including points, is reported on specific lines of Schedule A. For points reported in Box 6 of Form 1098, the amount is typically entered on line 8a. If points were paid but not included on Form 1098, or if points are being amortized, the deductible amount is entered on line 8c.

Maintaining accurate records for all mortgage-related payments, especially for amortized points, is important for future tax years. Consulting a tax professional is advisable for complex situations or any uncertainty regarding specific deductions.