Points paid on loans, other than certain home mortgage loans, are deducted ratably over the term of the loan (Code Sec. 461(g)). Penalty payments made for the privilege of prepaying mortgage indebtedness are currently deductible as interest (Rev. Rul. 57-198).

Points on a home mortgage loan for the purchase or improvement of, and secured by, a principal residence are deductible in the year paid to the extent that the payment of points is an established practice in the area, and the amount paid does not exceed the points generally charged in the area for a home loan (Code Sec. 61(g)(2)). You may also choose to amortize points over the life of their loan if, for instance, the standard deduction in the year the points were paid exceeds your itemized deductions, including the points (IRS Letter Ruling 199905033).

The IRS treats as deductible in the year paid any points paid by a cash-basis taxpayer that:

  • are designated as points on the RESPA settlement statement (Form HUD-1), for example, as loan origination fees, including amounts so designated on VA and FHA loans, loan discount, discount points, or points;
  • are calculated as a percentage of the principal loan amount;
  • are paid to acquire the taxpayer’s principal residence in connection with a loan secured by that residence;
  • are paid directly by the taxpayer, which may include earnest money, an escrow deposit, or down payment applied at closing, and not derived from loan proceeds; points paid by a seller, including points charged to the seller, are considered directly paid by the taxpayer from funds not derived from loan proceeds if they are subtracted by the taxpayer from the purchase price of the residence in computing its basis; and
  • conform to an established business practice of charging points for loans for the acquisition of personal residences in the area.

However, you cannot deduct points that may be in lieu of appraisal, inspection, title, and attorney fees, property taxes, or other amounts that are ordinarily stated separately on the settlement statement (Rev. Proc. 94-27).

This safe harbor does not apply to points paid for a loan to purchase a principal residence to the extent the principal amount exceeds the limit on acquisition indebtedness ($1 million for MFJ). Nor does it apply to points paid on home improvement loans, second or vacation home loans, refinancing or home equity loans, or lines of credit. The fact that a taxpayer cannot satisfy the requirements of the safe harbor does not necessarily mean that points are not currently deductible. It does mean that the IRS will not automatically consider them to be currently deductible.

Points paid to refinance a home mortgage are not deductible in full in the year paid, but must be deducted ratably over the period of the loan because they are incurred for the repayment of the existing indebtedness and are not paid in connection with the purchase or improvement of the home. The U.S. Court of Appeals for the Eighth Circuit, however, allowed a full deduction in the year paid for points on a long-term home mortgage loan refinancing a short-term balloon loan used to acquire the home (J.R. Huntsman, CA-8, 90-2 USTC ¶50,340). Also, the portion of the points allocable to the proceeds of a refinancing that are used for improvements may be deducted in the year paid. The portion allocable to the repayment of existing indebtedness or other purposes is deducted ratably over the period of the loan (Rev. Rul. 87-22).

A loan discount, i.e., where a lender delivers to an individual borrower an amount smaller than the face amount of the loan and the difference is the agreed charge for the use of borrowed money, is interest (Rev. Rul. 75-12).

Questions? Contact our New York office for more information. We are happy to help.

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