When you take a loan to purchase a first or second residence (or to refinance an existing loan on a first or second home), you generally will be charged closing costs (also known as settlement charges). These generally include points as well as attorney’s fees, recording fees, title search fees, appraisal fees, and other loan or document preparation and processing fees. The question you will face is whether you can deduct these fees immediately or whether they are added to the cost basis of your home.
Points are costs that are often charged to you by a lender when you take a loan secured by your home. One point equals 1 percent of the loan amount borrowed. (For example, 1.5 points on a $100,000 loan would equal $1,500.) If the points are charged for services provided by the lender in preparing or processing the loan, then they are not deductible. However, if the lender charges the points as up-front interest and in return gives you a lower interest rate on the loan, then the points may be deductible.
It doesn’t matter whether your lender calls the charge points or a loan (or mortgage) origination fee. If this charge represents prepaid interest, it may be deductible.
Points charged as prepaid interest are deductible over the term of the loan except when they are paid on a loan used to buy or improve your primary residence. Points are deductible for the tax year in which they are paid if you meet all of the following conditions:
For more information on deducting points, see IRS Publication 936.
If the loan is for the purchase of your primary residence, any points withheld by the lender will be deductible as up-front interest if (at or prior to the closing of the loan) you pay a down payment, escrow deposit, or earnest money equal to the charge for points. If, however, the loan is used to improve your primary residence, then the points paid related to the home improvement loan may be deducted in the year paid (if certain criteria are met).
Yes, these can be deducted by you as an up-front interest charge. However, because they are also considered a reduction in the cost of the home, you must lower your cost basis in the home by an amount equal to the points paid by the seller.
Yes, but they must be deducted ratably over the term of the loan.
If you pay $3,000 in points on a 30-year mortgage secured by a second home, you can deduct $100 in points each year during the term of the loan.
If the loan ends early (because, for example, you sell the home or refinance the mortgage), you may fully deduct the remaining points for the tax year the loan ends.
Points paid on a refinanced loan must be amortized over the life of the loan. However, there is one exception: If part of the loan is used to make improvements to your primary residence, you can deduct that portion of the points allocable to the home improvements made in the year the points are paid (if certain criteria are met).
Suppose you take a cash-out refinance mortgage for $100,000 and pay two points ($2,000). Then, $90,000 is used to pay off the principal debt owed on the old mortgage, $4,000 is used to pay off bills, and $6,000 is used to put in a new kitchen. Since 6 percent ($6,000 divided by $100,000) is used for home improvement, then $120 (6 percent of $2,000) may be deducted in the year the loan is taken. The remaining $1,880 in points must be deducted ratably over the life of the loan.
Other closing costs that are charged to you, such as attorney’s fees, recording fees, title search fees, appraisal fees, owner’s title insurance, and other loan or document preparation and processing fees, are not deductible. Rather, they are added into the cost basis of your home.
Over and above points, assume that your closing costs on a loan you take to purchase a $200,000 home total $1,500 dollars. Your initial cost basis in that home would be $201,500.
Fees that you pay at closing, placed in escrow to cover costs that you will be required to pay later (e.g., fire insurance premiums), are not added to the basis of your home.