Tuesday, September 18, 2007

SOME IMPORTANT POINTS ABOUT POINTS

Here is pretty much everything you always wanted to know about “points” – but didn’t know just who to ask:

A “point” is a percentage point charged to obtain a mortgage. One point on a $100,000 mortgage would be $1,000. Two points would be $2,000. Points (aka Loan Origination Fee, Loan Discount, Discount Points, etc) are usually reported on Lines 801-802 on the back of the standard HUD Closing/Settlement Statement.

Points paid to borrow money are deductible as interest on Schedule A. Generally, points are “amortized” over the life of the loan. Points on a typical 30 year mortgage are deducted over 360 months. If the points paid on a 20-year mortgage are $3,000 you can deduct $12.50 per month ($150 for a full year).

However you can deduct the total amount of the points paid on a loan used to buy, build or substantially improve your principal residence, and secured by that residence,
in full in the year paid.

If the seller of the property elects to pay all or part of the points in order to help the buyer obtain the mortgage, or as an additional incentive to buy, the seller-paid amount is considered to have been paid by the buyer.

In order to deduct the points in full in the year of purchase the amount of money paid at closing, including any seller-paid points and the initial down payment or deposit, must at least equal the amount of points charged. The points on a $300,000 mortgage are $6,000. You had initially given a $1,000 deposit and paid $25,000 at closing. The $6,000 is deductible in full on your Schedule A.

The mortgage lender will generally report the amount of points paid on the purchase of a principal residence on the Form 1098 sent to the borrower in January of the year following the sale. If this is the case the points are included in the amount reported on Line 10 of your Schedule A. Points not reported on a Form 1098 (including any amortization of points or the deduction of remaining “unamortized” points – see below) are reported on Line 12.

You do not have to deduct the points paid on the purchase of a principal residence in full in the year paid. You can elect to amortize the points over the life of the mortgage. Why would you want to do this? Consider the following example.

John and Jane Q Taxpayer close on the purchase of a principal residence in November of 2007. The total amount of points paid at closing is $2,500 and the interest paid on the mortgage for 2007 is also $2,500. The real estate tax adjustment on the Closing Statement is $458. This is the first principal residence for both of them – prior to the purchase J+J had rented an apartment. Their deductible state and local income taxes and charitable contributions add up to $4,142. Their itemized deductions for 2007 total $9,600. The 2007 standard deduction for a married couple for is $10,700. So they are not able to itemize on their 2007 Form 1040. They can elect to amortize the points paid on the purchase over the life of the mortgage loan so they will be able to get a tax benefit for the points in future years.

Be advised that if J+J will be victims of the dreaded Alternative Minimum Tax (AMT) for 2007 they may want to itemize, claiming the full amount of points paid, even though their deductions are less than the allowable standard deduction. The standard deduction is not deductible in calculating AMT. However mortgage interest and points paid on the purchase of a primary residence and charitable contributions are deductible for AMT purposes.

Points paid on the refinance of your principal residence and the initial purchase or refinance of a vacation home or a rental or investment property must be amortized over the life of the mortgage. However, if you refinance a mortgage on your principal residence in order to get additional money to “substantially improve” that residence you can deduct in full the points paid on the funds used for the improvements. A substantial improvement is one that adds value to the home or prolongs its useful life.

If you pay-off a mortgage on which you have been amortizing points early (i.e. you sell the property or refinance the mortgage with a new lender) you can deduct the amount of “unamortized” points on that mortgage in full in the year of the pay-off.

Let’s say you paid $3,600 in points on a 30-year mortgage to purchase a vacation home. You have deducted a total of $540 in points on prior years’ tax returns through 2006. You sell the home in January of 2007. You can deduct $3,060 in points on your 2007 Schedule A ($3,600 - $540). If it was a rental property the points would be deducted on Schedule E.

This does not work if instead of selling the property in January you refinance the mortgage with the same lender. Using the numbers from the above example let us say that you initially purchased the vacation home with a mortgage from Bank of America. In 2007 you refinance the mortgage with Bank of America to get a lower interest rate and to reduce the term from 30 years to 15 years. There are no points on the refinance. Because you refinanced with the same lender the remaining $3,060 in “unamortized” points must continue to be amortized at $17 per month over 180 months.

Deductible points are limited by the same $1 Million in acquisition debt as mortgage interest deductions.

Did I miss anything?

TTFN

11 comments:

Anonymous said...

Hello,

I'm amoritizing points, and my mortgage was sold. Do I still amoritize points to the original lender? Amoritize with the new lender? Or, was I supposed to deduct the full amount of the points in the year that the loan was sold?

Robert D Flach said...

Anon-

If you did nothing, but your mortgage was sold from one company to another (i.e. from Citibank to GMAC) you should continue to amortize your points over the life of the original mortgage just as you have been doing all along. You still have basically the same loan – you are just making payments to a different company.

If you went out and actually refinanced your mortgage with a new company (i.e. old mortgage with Citibank, but new mortgage with GMAC) then you would deduct in full the amount of “unamortized” points (the amount of total points remaining on the old loan) from the first (Citibank) mortgage in the year the refinance took place. If you paid $3000 in points on the first loan, and you had deducted points totaling $500 on past tax returns, you would deduct $2,500 in “unamortized points” on your 2007 Schedule A if you refinanced the loan with a new company in 2007. If the new refinanced loan also included points, you would also begin to amortize these new points over the life of the new mortgage on the 2007 return.

If you refinance your mortgage with the same company (i.e. old mortgage with Citibank and new mortgage also with Citibank) you would combine any “unamortized” points from the old mortgage with any points paid on the new mortgage and amortize the total amount over the life of the new loan. When you refinance with the same company you cannot deduct “unamortized” points from the old mortgage.

I hope I have been of help.

TWTP

Shay said...

I bought my house in August 2008. I'm doing my taxes and need to know if I can deduct the total dollar amount shown for points paid in box 2 of my 1098?

Robert D Flach said...

Shay-

If the amount in Box 2 is the total amount of points you paid on the purchase of your personal residence (compare to Points reported on page 2 of your Closing Statement), and this amount is less than the total amount of your deposit and the amount paid out-of-pocket at the closing, then YES.

TWTP

Shay said...

Hello, this is Shay again thanks so much for such a fast response! I didn't pay anything out of pocket, we used the Nehemiah Program, (down payment assistance program), which paid 3% of the sales price. So would that count towards money out of pocket at closing in order for me to fully deduct points paid?

Shay said...

Oops, it's not called the Nehemiah Program, it's called Ameridream.

Robert D Flach said...

Shay-

WTF are you talking about? I am totally confused!

TWTP

Robert D Flach said...

Shay-

For some reason your second comment response appeared in my inbox box before the first one.

I know absolutely nothing about the programs you mentioned, so I cannot answer with authority.

My initial thought would be that the program gave you a grant (gift) and you used that to make the payment at closing - just as if your Uncle Herbie had given you the money - so the points would be deductible. However I would need to know more about the program.

That being said, please do not tell me more about the program. If you are unsure ask your tax professional.

TWTP

Kelsey said...

Hi!Thanks for the informative post. I am planning to buy a house so was researching which mortgage or home loan is good for me for finance and came through your post.

Bill Stewart said...

Robert, from many refis I've seen, the unamortized portion is always taken as paid in full and deducted in full on the return following the refi. Even if refinancing with same lender. (Rarely happens) Where did you find rule clarifying this?

Robert D Flach said...

BS-

IRS Pub 936:

"Mortgage ending early. If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. However, if you refinance the mortgage with the same lender, you cannot deduct any remaining balance of spread points. Instead, deduct the remaining balance over the term of the new loan."

RDF