First Time Homebuyer – Deducting Points

 

Tax Issue

 

Points paid to purchase a home are fully deductible in the year paid if the loan meets certain criteria. However, first-time homebuyers who purchase a residence late in the year often find they do not have enough mortgage interest or property taxes accumulated to benefit from itemizing deductions. The deduction for points paid on the purchase of their home may be lost.

 

Applicable Tax Law

 

  • For points to be deductible, the loan must be secured by the taxpayer’s main home, paying points must be an established business practice in the area, the points paid most not be more than are normally charges, the taxpayer must use the cash method of financial record keeping, the points must not be paid for services, and the funds paid at closing must be at least as much as the points charged.
  • Deductible points paid at closing to purchase a home are generally included as mortgage interest on Schedule A, Form 1040.
  • Deductible points paid may be deducted in full in the year paid or amortized over the life of the mortgage.
  • If points are being deducted over the life of the mortgage, and the mortgage is paid off early (such as another refinance or sale of the house), then any remaining balance is deductible in full in the year the mortgage ends unless the mortgage is refinanced with the same lender.
  • Points paid on obtaining a permanent mortgage to refinance short-term debt are deductible in full in the year paid if the points are paid in connection with the purchase of the main home.
  • If the seller pays the points, the buyer is treated as having paid the points. The buyer deducts the points as an itemized deduction and then reduces the home’s basis by the amount of seller-paid points.

Tax Planning Strategies

 

A taxpayer, in the situation of incurring deductible points in a year in which he or she doesn’t have enough deductions to itemize, may choose to amortize the points over the life of the mortgage rather than allowing the current deduction. Electing to amortize the points paid for the purchase of the home preserves the tax benefits by extending the deduction into future years. Although the yearly deduction may be small when amortized over 15 or 30 years, a large deduction can be waiting for the taxpayer if the mortgage is paid off early.

 

Examples

 

Example #1: Matt bought his first home in November 2012. Matt is single. He paid $2,400 in points to get a 30-year $80,000 mortgage. He made his first mortgage payment in December 2012. For 2012, his itemized deductions including the points paid, total $4,750. His standard deduction is $5,950. Since his standard deduction for 2012 is greater than his itemized deductions, Matt should amortize the points paid over the 30-year life of the mortgage. His calculation would be as follows:

  • $2,400 (points paid) ÷ 360 (monthly payments) = $6.67 (monthly deduction)

Since he made one mortgage payment in 2012, he must allocate one month’s amortization, or $6.67 to 2012.

For 2013 through 2040, he will deduct $80 each year.

  • $2,400 (points paid) ÷ 360 (monthly payments) x 12 (payments per year) = $80

 

In 2041, Matt will only deduct 11 months worth, or $73.33.

 

Example #2: Dan paid $3,000 in points when he purchased his house in October 2001. He amortized those points over the 30-year life of the mortgage. Through 2011, Dan has deducted $1,025 of the points as follows:

 

2001 (3 months) ………………………………………$     25 ($3,000 ÷ 360 x 3)

2002-2001………………………………………………..$1,000  ($3,000 ÷ 360 x 120)

$1,025

 

Dan prepaid his mortgage in full in January 2012. He can deduct the remaining $1,975 of points ($3,000 – $1,025) in full in 2012.

 

Example #3:  Assume the same fact as Example #2, except that instead of paying off the mortgage in full, Dan refinances his mortgage with a different lender. Dan can still deduct the remaining $1,975 of points in full in 2012. If, in addition, he pays deductible points to obtain the refinance, Dan will amortize those points over the life of the new mortgage. He does not have the option of deducting points in the year paid for a refinanced mortgage.

 

Example #4: Assume the same facts as Example #3, except that instead of refinancing with a different lender, Dan refinances his mortgage with the same lender. The refinanced mortgage is a 15-year mortgage. In this case, Dan will amortize the $1,975 remaining points over the 15-year life of the loan. His annual deduction will be $10.97 per month ($1,975 ÷ 180).

 

Possible Risks

 

  • If the taxpayer continues to be in a situation where the standard deduction is greater than his or her itemized deductions, the deduction will still be lost.
  • If the taxpayer refinances the loan with the same lender, any remaining balance is deducted over the life of the new mortgage.