Your mortgage is a debt, but if you play your cards right you can use it to generate some tax advantages. One of those advantages is deducting your mortgage interest, including points. Whether it's a new mortgage or you're refinancing, knowing when and how to deduct points is key to saving on your tax bill.
For you to deduct points, your mortgage refinance has to meet the conditions for home mortgage interest deduction set out by the Internal Revenue Service. In short, your mortgage must be a debt secured by a qualified home. Your home secures a debt when a contract says it can be used to pay off the loan if you go into default. A qualified home is your main home -- the home where you choose to live most of the time. A second home can also be a qualified home if you don’t rent it out during the year. If you rent it out, you have to live in it during the year for the greater of 14 days or 10 percent of the days you rent it out.
Deductions Spread Out
Your bank typically calculates mortgage refinance points as a percentage of the overall mortgage loan amount. You usually can't deduct all your mortgage refinance points in the year paid because they're prepaid interest costs for all future years. Unless you meet certain conditions, points paid for refinancing have to be spread out and deducted over the lifetime of the loan.
Deductions Allowed Immediately
You might be able to deduct a larger portion of your mortgage refinance points in the year paid if you used some of the refinance funds to pay for improvements on your main home. You have to meet the following conditions: the loan is secured by your main home rather than a second home; points and their amount are consistent with established business practices in your area; you report income in the year you receive it; the points don’t include items usually stated separately on a settlement sheet, such as appraisal, title and inspection fees; the funds you provided at closing are higher than the points charged and you didn't borrow the money to pay your points. You can write off immediately the points relating to the portion of the loan amount you used for improvements to your main home. Any points you can't deduct immediately you usually can spread out and deduct over the life of the refinance term.
You might not be able to claim all of your points depending on the size and type of mortgage refinance. If you refinance a loan intended to buy, build or improve a qualified home, you can claim all of your points for loans up $1,000,000 and get a partial deduction for mortgage amounts over that limit. If your refinance is for any other reason -- a home equity loan for example -- the limit to fully deduct your points is $100,000; you can't deduct the portion of points for loans above that amount as home mortgage interest. If you use the refinance loan to make an investment, you might be able to deduct your excess points as investment expense. Cut both those limits in half if you’re married and filing separately.
Philippe Lanctot started writing for business trade publications in 1990. He has contributed copy for the "Canadian Insurance Journal" and has been the co-author of text for life insurance company marketing guides. He holds a Bachelor of Science in mathematics from the University of Montreal with a minor in English.