Writing off home refinancing points

We just got a letter from our former mortgage holder. The lender informed us that it "has received payment in full of your mortgage loan" and is in the process of "preparing the appropriate documents" to release the lien on our home.

No, the hubby and I aren't having a mortgage burning party. We simply refinanced our loan.

When we bought our Austin house seven years ago, we got what was at that time a great home loan rate. But as the rates kept dropping this year, we finally got our act together and got a new, lower rate loan on our abode.

Since we have good credit ratings, we got the best possible rate this time around, too, without having to pay points.

Each point is one percent of the mortgage amount and points are used when rates are high to buy down the loan rate.

But even with today's historically low rates some folks still might need, or want, to pay points for the best possible rate. 

If that's your situation, the good news -- and today's Weekly Tax Tip -- is that the refi points are tax deductible.

The bad news is that they aren't deductible all at once.

Rather than deducting the full amount of refi points in the tax year in which you paid them, you must amortize them over the life of the loan.

Here's how it would work for that one point you paid to get a good rate on your 15-year refi loan of $150,000:

$1,500 in points
÷ 180 total payments
= $8.33 per payment
x 12 payments per tax year
= $100 deduction on each tax return
for the next 15 years.

Other home loan deductions: The other home-related tax breaks are the same for the refinanced loan.

The only difference likely will be that the amount of your mortgage interest deduction will be smaller than it was. 

That's a monthly cash flow vs. tax deduction trade-off we're willing to take. Our new loan will save us around $450 a month.

Next spring, the first tax filing season after our refi, we also need to have our closing statement handy.

On that document we'll find the interest we paid on the loan for the time between the refinancing and when our first payment is due. That amount won't be included on the year-end interest statement we'll get from our new lender, but it's deductible.

We pay our property taxes directly, so we didn't have to make payments at our refi closing.

But if your home loan payment includes tax money so your lender can make this annual payment on your behalf, be sure to note the prorated share of the tax on your closing statement. It's also deductible.

You also might find these items of interest:

• Home sale profits usually don't create
  any tax bills for residential sellers
• Tax treatment of forgiven foreclosure debt
  and other canceled debt situations
• The unfairness of housing tax breaks?

Comments

[skbell1]

Penny, this is not as common, but it appears that negative points also could be deductible. A borrower receiving negative points is analogous to a corporation receiving a bond premium. Corporations issue bonds at a premium because the bonds pay a higher interest rate than the market demands for a bond with the same characteristics (risk, duration, features, etc.). The bond premium represents a reduction of interest expense that is amortized over the life of the loan (IRC §171 and IRS Reg. 1.171-2). Therefore, amortizing negative points over the life of the mortgage is consistent with corporate treatment of a bond premium. That is, the amortization reduces the interest deduction on the home loan. Furthermore, amortizing negative points over the life of the loan is consistent with the general rule for tax treatment of positive points. However, I suggest you talk with a tax pro who specializes in real estate transactions.

Note also that there is a school of thought that if the negative points are all used to cover closing costs, any actual receipt of the negative points as cash could mean that the recipient of the points would be liable for income tax on that amount. Again, check with a tax pro.

thanks for reading and good luck on your refi.

[Penny J Leisch]

We are also looking at refinancing. What happens when there are negative points involved, which is happening on ours?

[skbell1]

Yes, D, you do ... unless.

First to the "yes" part. The IRS says you can deduct any remaining balance of the points in the year the mortgage ends. That termination could be by prepayment, refinancing or, let's hope not, foreclosure. Say, for example, our hypothetical refinancer got his loan three years ago.

Now to the "unless" portion. When the second second refinancing is with the same lender, the IRS says you cannot immediately deduct the remaining balance of your first refi's points. Instead, those points you're amortizing from the first refi are added to your new refinance amount. You then continue to deduct them, and any additional points you may have paid for the second refi, for the life of your new loan.

[D]

So if you are deducting $100/year and then refinance in the 2nd year, do you take the rest of $1300 all at once in that last year?