Can You Deduct Points Paid on Purchase of Principal Residence?

Homebuyers often encounter “points” during the mortgage process and may wonder about their tax implications. The cost of these points, a form of prepaid interest paid to a lender to secure a lower interest rate, can sometimes be deducted on your federal income tax return. The ability to deduct the full amount in the year of purchase is not automatic. It depends on meeting a specific set of tests established by the Internal Revenue Service (IRS). Failing to meet these requirements does not eliminate the tax benefit, but it changes how the deduction is claimed over time.

Rules for Deducting Points in the Year of Purchase

To deduct the full amount of mortgage points in the year you paid them, you must satisfy several IRS conditions. The loan must be secured by your main home, which is the home you live in most of the time. This deduction is for the purchase of a principal residence, and the loan must be used to buy or build it.

The payment of points must be an established business practice in the area where the loan is made. The amount of points you pay cannot be substantially more than what is generally charged in that area. This prevents taxpayers from paying an excessive amount in points to generate a large, immediate tax deduction. The points must also be computed as a percentage of the mortgage’s principal amount and be clearly itemized on your loan documents.

You must use the cash method of accounting, which is how nearly all individuals report income and expenses. This is a requirement for the immediate deduction of points. The points cannot be a substitute for other fees listed separately on a settlement statement, such as appraisal fees, inspection fees, title fees, or property taxes.

The funds you provide at or before closing, including your down payment, must be at least as much as the points charged. You cannot have borrowed the money to pay the points from your lender or mortgage broker. If the seller pays for any of your points, the IRS treats them as if you paid them directly, and you can deduct this amount.

Deducting Points Over the Life of the Loan

If you do not meet all the tests to deduct your points in the year of purchase, you must deduct them over the life of the loan. This method, known as amortization, involves spreading the deduction out over the term of the mortgage. This situation also applies to mortgage refinances, where points paid must be deducted over the new loan’s term.

The calculation for amortizing points involves dividing the total amount paid for points by the total number of monthly payments for the mortgage. For example, if you paid $3,600 in points on a 30-year mortgage (360 monthly payments), your monthly deduction would be $10. For a full year of payments, you could deduct $120.

While this provides a smaller annual deduction compared to taking it all in one year, it offers a consistent tax benefit throughout the loan. This is the standard method for points paid on loans for second homes and rental properties as well.

How to Claim the Deduction

To claim the deduction, you will need your final closing disclosure or settlement statement and the Form 1098, Mortgage Interest Statement, your lender sends annually. The closing statement will show the amount you paid for points, often labeled as “loan origination fees,” “loan discount,” or “discount points.”

The deduction for mortgage points is an itemized deduction, meaning you must file Schedule A (Form 1040) and cannot take the standard deduction.

The overall limit for the home mortgage interest deduction also includes points. For mortgages taken out after December 15, 2017, the deduction is limited to interest on up to $750,000 of home mortgage debt ($375,000 if married filing separately). For mortgages originated on or before that date, the limit is interest on up to $1 million of debt ($500,000 if married filing separately).

The process for reporting points on Schedule A depends on your Form 1098. If the points are included in Box 6 of Form 1098, you will include this amount with your total mortgage interest on line 8a. If you paid deductible points that were not reported on your Form 1098, you must report them separately on line 8c.