Most homebuyers take out a mortgage to pay for the purchase of a home. Typically, mortgage lenders charge borrowers certain up-front costs, known as loan origination fees, at the closing. To make a loan origination fee deductible, it must represent prepaid mortgage interest, also known as points.
Points, or prepaid mortgage interest charges, are the only loan origination fees that are tax deductible.
Origination Fee vs. Points
Points are a type of home loan origination fee. They are up-front interest charges that help induce the lender to make the loan. As explained in IRS Publication 936, points are tax deductible but other loan origination fees are not. These other fees include preparation costs, notary fees, property taxes, appraisal fees and mortgage insurance premiums. For points to be fully deductible in the year paid, the loan must be secured by your main home and be used to buy or build that home. Also, paying points must be a typical business practice in your area. Furthermore, the points must not exceed the usual amount for the vicinity, cannot be used to pay for other fees, must be calculated as a percentage of the mortgage principal and must be listed on the mortgage settlement statement. Points on a home improvement loan are also deductible.
Exceptions to Immediate Deduction
In certain cases, part of or all of the points paid must be deducted over the life of the mortgage rather than in the first year. This holds true when you refinance an existing mortgage for your main home or finance a second home. It’s also true if you pay more points than is customary for your area, in which case you’ll pay off the excess points over the life of the mortgage. If you use some of the refinancing proceeds to improve the property, you can immediately deduct a prorated percentage of the points. For example, suppose you pay three points ($6,000) on a 15-year, $200,000 mortgage to refinance your current home and plan to use 20 percent ($40,000) of the proceeds to upgrade the property. You can therefore deduct 20 percent of your points, or $1,200, in year one and the remaining $4,800 in equal installments over the subsequent 14 years.
2018 Tax Law
The Tax Cuts and Jobs Act of 2017 made one change affecting the deduction of points in tax year 2018. If the mortgage amount exceeds $750,000, only points allocable on a prorated basis to this amount are immediately deductible, while the excess must be deducted over the life of the mortgage. For example, on a four-point, $1,000,000 mortgage, three points (4 x $750,000/$1,000,000), or $30,000, are immediately deductible, and the remaining one point ($10,000) can be deducted in equal installments over the remaining term of the mortgage.
2017 Tax Law
For tax year 2017, the maximum mortgage amount for immediate point deduction was $1,000,000. For example, you could immediately deduct all points on a four-point, $1,000,000 mortgage taken out in 2017.