Are Points Paid on a Mortgage Tax Deductible?

Mortgage points are fees paid to a lender in connection with a home loan. These fees can either reduce the interest rate (discount points) or cover loan processing costs (origination fees). Both types are considered points for tax purposes. Specific rules and conditions apply to their deductibility.

General Requirements for Deductibility

For mortgage points to be fully deductible in the year they are paid, several specific criteria must be satisfied. These rules primarily apply to points paid on a loan used to purchase or construct a main home. The Internal Revenue Service (IRS) considers these points as a form of prepaid interest.

A primary condition for deducting points in the year paid is that the loan must be secured by your main home. The property serves as collateral for the mortgage. Additionally, paying points must be an established business practice in the area where the loan originated. The amount of points charged should not be excessive when compared to standard charges in that region.

The points must be calculated as a percentage of the principal loan amount. One point typically equals one percent of the total mortgage. Loan documents, such as the settlement statement or Closing Disclosure, must clearly show the points as a charge for the mortgage.

The borrower must generally pay the points directly. This payment does not necessarily require out-of-pocket cash at closing; funds withheld from the loan proceeds can also satisfy this requirement. However, funds borrowed from the mortgage lender or broker to pay the points are typically not considered as paid by the borrower for this deduction.

The loan proceeds must be used to acquire or build your main home. If all these conditions are met, the points are usually treated as prepaid interest and are fully deductible in the year they are paid.

Specific Scenarios for Deducting Points

The deductibility of mortgage points can vary significantly based on the type of loan and how its proceeds are used. Different rules apply to refinanced mortgages, home equity loans, and situations involving seller-paid points, altering the immediate deduction possibilities.

Points paid on a refinanced mortgage are generally not fully deductible in the year paid. Instead, these points must be amortized, meaning they are deducted equally over the entire life of the new loan. For example, if $3,600 in points are paid on a 30-year refinanced mortgage, $120 ($3,600 divided by 30 years) would be deductible each year. If the home is sold before the loan term ends, any remaining unamortized points can typically be deducted in the year of sale. An exception to this amortization rule exists if a portion of the refinanced loan proceeds is used for substantial home improvements, in which case the points related to the improvement portion may be fully deductible in the year paid.

For home equity loans or home equity lines of credit (HELOCs), points are generally not deductible unless the loan proceeds are used to buy, build, or substantially improve the home that secures the loan. If the funds are used for such purposes, the interest, including points, may be deductible, though often still subject to amortization over the loan’s life. Conversely, if the funds are used for other purposes, such as debt consolidation or personal expenses, the points are not deductible.

When a seller pays points on behalf of the buyer, the buyer may still be able to deduct them. The IRS treats these seller-paid points as if the buyer indirectly paid them, often by considering the purchase price to be higher. However, the buyer’s tax basis in the home, which is used to calculate gain or loss when the property is sold, must be reduced by the amount of seller-paid points deducted.

Points paid on a loan for substantial home improvements can be fully deductible in the year paid, provided the loan is secured by the main home and meets other general deductibility criteria. Points paid during the construction phase of a new home are typically fully deductible in the year the home is occupied and the mortgage loan closes.

How to Claim the Deduction

Claiming the deduction for mortgage points involves specific steps and requires accurate documentation. The process hinges on whether a taxpayer itemizes their deductions.

The primary document for information regarding mortgage interest and points paid is Form 1098, “Mortgage Interest Statement.” Lenders are required to send this form to borrowers by early February each year. Taxpayers should locate Box 6 on Form 1098, which specifically reports “Points paid on purchase of main home.” This box indicates the amount that may be fully deductible in the year paid.

To claim a deduction for mortgage points, taxpayers must itemize their deductions on Schedule A (Form 1040), “Itemized Deductions.” This means that the total of all itemized deductions, including mortgage interest, state and local taxes, and charitable contributions, must exceed the standard deduction for the taxpayer’s filing status. If the standard deduction is greater, it is generally more beneficial to claim the standard deduction.

For points fully deductible in the year paid, as reported in Box 6 of Form 1098, the amount is typically entered on Line 8a of Schedule A. If points were paid but not included in Box 6 of Form 1098, or if the deduction is for amortized points, the deductible portion for the current year is generally reported on Line 8c of Schedule A. Taxpayers deducting amortized points, such as those from a refinance, must maintain a record of the amortization schedule to correctly calculate the deductible amount each year.

Maintaining thorough records is important for substantiating the deduction. Taxpayers should retain all relevant closing documents, such as the Closing Disclosure or Form HUD-1, as proof of points paid. These records are particularly important for amortized points, as they provide a basis for deductions over multiple years, and if the home is sold before all points are deducted.