When looking at your mortgage interest for the year on form 1098, have you ever wondered what “points paid on purchase of principal residence” are or whether they are deductible? Maybe you were lucky enough to have the seller pay those points. Are they still deductible?
The simple answer to these questions is yes, subject to some important limitations which I will list below.
Points - up-front fees charged by a mortgage lender, expressed as a percentage of the loan principal - are normally the buyer's obligation. Sellers will sometimes sweeten a deal by agreeing to pay the points on the buyer's mortgage loan.
In most cases, points the buyer pays are a deductible interest expense. And IRS says that seller-paid points may also be deductible.
Suppose, for example, that you bought a home for $600,000. In connection with a $500,000 mortgage loan, your bank charged two points, or $10,000. The seller agreed to pay the points in order to close the sale.
You can deduct the $10,000 in the year of sale (usually preferable) or over the life of the loan. The only disadvantage is that your tax basis in the home is reduced to $590,000, which will mean more gain if and when you sell the home for more than that amount. But that may not happen until many years later, and the gain may not be taxable anyway. You may qualify for an exclusion for up to $250,000 ($500,000 for a husband and wife who file jointly) of gain on the sale of a principal residence.
There are some important limitations on the rule allowing a deduction for seller-paid points. The rule doesn't apply:
- to points that are allocated to the part of a mortgage above $1 million;
- to points on a loan used to improve (rather than buy) a home;
- to points on a loan used to buy a vacation or second home, investment property, or business property; and
- to points paid on a refinancing, home equity loan, or line of credit.One thing to keep in mind is that deductible points are an itemized deduction. If you
usually take the standard deduction and purchase your home late in the year, it may be best to deduct the points over the life of the loan as to not lose the deductibility of the points (assuming that in the following years your will itemize due to the increase in interest expense, taxes, and points).
If you are purchasing a home soon and wondering about the affect it will have on your tax return, please contact your accountant at Cook Martin Poulson, P.C. who will help you determine the effects of the purchase.