In the purchase of a new home you (or the seller) may have paid "points" to your mortgage lender. Since a current tax deduction for points in the year in which they are paid would be a significant benefit, I'd like to take this opportunity to explain how the rules in this area operate.
Ordinarily, the costs of borrowing money (including amounts paid as "points") cannot be deducted in the year they are paid, but instead can only be deducted over the life of the loan to which the costs relate. However, IRS has set forth a "safe harbor," under which points can be deducted in the year they are paid if all of the following requirements are satisfied:
- You must be on the cash method of accounting for tax purposes. I have reviewed your tax returns for prior years, and you have historically used the cash method.
- The points must be paid in connection with the acquisition of your principal residence.
- The mortgage loan must be secured by that residence.
- You must have paid the points directly from funds that you did not borrow, or else the seller must have paid the points on your behalf. In other words, no current deduction is available if the amount of the points was withheld from the loan proceeds by the lender.
- There must be an established business practice in your area of charging points on loans of this type, and the amount you paid must not exceed the amount generally charged in your area.
- The points must be clearly designated as such on the Uniform Settlement Statement prepared in connection with the closing.
- The amount of the points must be computed as a percentage of the stated principal amount of the mortgage.