When you have a hefty mortgage payment to make, saving money may be top on your list. Becoming a homeowner comes with more benefits than being able to paint your walls whatever colors you like. You also have the chance to take tax deductions that renters cannot, such as a mortgage points tax deduction.
Mortgage points must be marked as such on your mortgage statement to be tax deductible.
Paying Points Up Front
Mortgage points are extra money you pay up front on a mortgage loan. Each point equals 1 percent of the total mortgage amount, and there are two types of points. One type is referred to as discount points and serves you by lowering your interest rate. The other type is called origination points and compensates the lender for some of the costs of processing your mortgage.
Mortgage Points and Tax Deduction
Mortgage points paid on a purchase of a principal residence are usually tax deductible. Internal Revenue Service (IRS) rules, however, dictate that you can only fully deduct your points if the mortgage is secured by your main residence, you use the cash method of accounting for tax purposes and charging points is the norm in your area. Additionally, the points are only deductible if they are a percentage of your mortgage principal and are marked on your statement as mortgage points.
Points for Refinancings
Refinance loan points can be tax deductible. Subject to IRS rules for when discount points are tax deductible and when origination points are tax deductible, taxpayers usually have to deduct refinance points gradually over the life of the loan term. If you use some of the refinance mortgage money to make improvements to your home, however, you may deduct the points related to the improvements in the same tax year you paid them.
Restrictions on Tax Deductions
You cannot deduct all of your mortgage points in the year in which you paid them if the points were paid for things that are usually listed separately on settlement statements. For example, points paid for appraisal and inspection fees are not tax deductible. Those paid for attorney and title fees or property taxes are not tax deductible either. Additionally, points for a mortgage that is not secured by your primary residence have to be deducted gradually over the loan term rather than in the tax year you paid them.
If your home mortgage amounts to more than $1,000,000, you cannot deduct all of your points. The same goes if the equity you have in your home exceeds this amount. In such a case, you'll have to use IRS Publication 936 to figure out how much you can deduct.