By: Jessica Zimmer, Debt.com Financial Fitness Trainer
If you refinanced a mortgage in 2011, you may be able to deduct points from your taxes as home mortgage interest. Points are charges that a buyer pays to get a home mortgage. The buyer typically pays the cost of points at the time of closing. The purpose of buying points is to secure a lower interest on the mortgage. There are two types of points: origination points, which compensate the lender for offering the loan; and discount points, which are prepaid interest. You can also deduct the amount that you paid for discount points from your federal taxes. A lender typically allows a buyer to buy between one to three discount points.
The cost of a discount point is 1% of the mortgage. This means that the cost of one discount point on a $160,000 home is $1,600. Each point typically lowers the interest rate on a mortgage by 0.125%. If a bank offered a 4.5% interest rate on a mortgage, the purchase of two discount points would lower the interest rate to 4.25% (0.0425).
The IRS states that if you can deduct all of the interest on your mortgage, you may be able to deduct all the discount points paid on the mortgage. You are eligible to deduct the price of discount points if you meet certain qualifications. First, your acquisition debt: the debt to construct, improve, or purchase the home, must be equal to or less than $1 million. Also, your home equity debt, the amount you have borrowed against the home, must be equal to or less than $100,000.
In addition, you must meet six key requirements. The mortgage must be secured by your main home, the home where you live most of the year. Paying points must be a regular business practice in your area. The number of points you paid must be equal to or less than the number generally charged in your area. You must have used the cash method of accounting for 2011. This means that you report income in the year you receive it and deduct expenses in the year that you pay them.
The points must not be paid for charges usually stated separately on the settlement sheet, such as property taxes and appraisal fees. The amount you paid at or before closing must be equal to the amount of the points. This means that you cannot have borrowed money from the lender or a broker to pay the points.
If you meet all of these conditions, you likely will be able to enter the amount you paid for your points into your list of itemized deductions on IRS Form 1040, Schedule A. Generally, points that you pay to refinance a mortgage are deductible only over the life of the new loan. If you use part of the refinanced mortgage amount to improve your main home, you may be able to deduct part of the points related to the improvement in the year that you paid the points with your own money.
You may need to meet several other requirements to deduct discount points. In addition, your adjusted gross income may subject you to a limitation on some itemized deductions, including points.
For more information, consult IRS Tax Topic 504: Home Mortgage Points.
© February 15, 2012 // Copyright all material 2/15/12 by Jessica Zimmer