Tax-Deductibility of Paying Points

Q. Are the points paid to obtain a mortgage deductible?  My brother refinanced his home last year and he deducted the point(s) he paid of his taxes in April.  It’s my understanding that only a portion of it is deductible.  Whose right?

A.  Most likely, you are, but your brother might also be, in certain instances.  Traditionally, the rule of thumb has been that writing off “points” (one point equals 1% of the loan amount) paid for a home loan only applied to a purchase transaction.  If an individual paid points in connection with a refinance transaction, the points could not be deducted in one lump sum, but instead amortized over the term of the loan.  For example, if you refinanced a $300,000 30-year mortgage and paid one point, the $3000 would have to be spread out over the 30 year term.  The deductible amount would be 1/30th each year or $100 per year.  If your tax bracket were 33%, the tax savings would be a measly $33 per year.  But, if the entire $3000 could be written off in the tax year paid and not spread out over the term of the loan, the tax savings could increase significantly from $33 to $990 ($3000 X 33% = $990).

A recent tax court case, however, may provide the necessary loophole for your brother and allow him to write of points paid on a refinance transaction.

In a recent case brought before the United States Tax Court (Hurley 2005-125), the court ruled that the points paid for refinancing a property were tax deductible due to certain criteria being met by the Hurley’s.  The case was brought to the Tax Court with the argument that the points paid for the home loan allowed the Hurley’s to obtain a lower rate, which resulted in a lower home loan payment.  The monthly payment savings were in turn used for improvements to the property, including a new roof, carpet, and other repairs.  Being that the Hurley’s provided the documented proof of the improvements, the court ruled in their favor and allowed the points to be deducted from the Hurley’s taxes…all in the year the loan was refinanced.

It is important to note that if you pay point to refinance a personal property, the points are only tax deductible if the refinance creates a lower home loan payment and the savings will be used for improvements to the property; or if the refinance transaction is being done to purchase an additional property. And as always, consult your mortgage and tax professional regarding your own specific situation to ensure that you meet the criteria needed for a deduction of this type.

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