Home Mortgage Points For Refinancing

Home Mortgages

Points Paid at Closing

Refinancing a Principal Residence

Executive Summary: When a home is refinanced, the mortgage points are tax write-off's, but must be deducted ratably over the number of payments required.

Points paid for a mortgage refinancing are not deductible when paid but, instead, must be capitalized and amortized over the term of the new loan (Rev. Rul. 87-22). Amortization is computed ratably based on the number of periodic loan payments made in the tax year to the total periodic payments for the term of the loan (Rev. Proc. 87-15). If the loan is paid off prior to maturity (e.g., the residence is sold and the loan paid off, or the loan is refinanced), the remaining unamortized balance of the points can be deducted in that tax year (Ltr. Rul. 8637058). However, if the mortgage loan is refinanced with the same lender, the unamortized points generally must be deducted over the term of the new loan, rather than in the year the loan to which the points pertain ends (IRS Pub. 936). But, if the borrower paid an amount at least equal to the points at closing of the first refinancing (i.e., the loan to which the unamortized points relates) and that loan is subsequently refinanced with a different lender, it appears that the unamortized points can be deducted in the year of the subsequent refinancing. This is similar to the rule that allows cash-basis taxpayers to deduct expenses that are paid with borrowed funds, as long as the funds are not borrowed from the provider of the goods or services that give rise to the expense. Bob Parrish has a Worksheet ( Mortgage Points Worksheet ) that can be used to keep track of amortized points.

Observation: Rev. Proc. 87-15 provides that points are amortized ratably based on the number of principal payments made (rather than the amount of principal reduction) each year relative to the total. Thus, the authors believe that, assuming that they otherwise qualify for amortization, points paid on a balloon note (e.g., a three-year loan on a 15-year amortization period) would be amortized over three years.

Example 29D-7 Points paid for refinancing a principal residence loan.
Bum refinanced his $150,000 mortgage on his principal residence at a lower interest rate in 2003, paying two points ($3,000) to do so. He paid the points out of his own funds at closing (i.e., they were not added to the debt). All of the proceeds of the new loan were used to pay off the old loan. Since the old loan represented acquisition indebtedness, the new loan is treated the same way. Can Bum take an immediate qualified residence interest deduction for the $3,000?

Since the loan proceeds were not used for purchasing or improving the residence, the points paid by Bum on the new loan do not meet the requirements of IRC Sec. 461(g)(2) and thus are not currently deductible. They must be amortized over the term of the loan.

Variation: If Bum had borrowed $200,000 and used $50,000 on improvements to his residence and the remaining $150,000 to refinance his old loan, 25% of the points would be deductible in 2003. The remaining points would be amortizable over the term of the loan.

While it is clear that Rev. Rul. 87-22 applies to points paid in a traditional refinancing where a long-term mortgage loan is refinanced with one at a lower interest rate (Kelly), its application to other types of refinancing is less certain. In Huntsman, points were paid to refinance a three-year note used to purchase a principal residence. Even though the original purchase note carried such a short term that it was obvious the taxpayer would have to refinance, the Tax Court did not consider the refinancing transaction to be in connection with the purchase of the residence. Thus, the Tax Court concluded that the mortgage refinancing points should be capitalized and deducted over the term of the loan rather than deducted on the front end. The key to the decision was the Court’s narrow interpretation of the exception to the prepaid interest rules for points on debt incurred for the purchase or improvement of a principal residence.

Upon appeal, the 8th Circuit Court of Appeals reversed the Tax Court and concluded that the meaning of “in connection with” the purchase of a home should be broadly construed. In this case, it was obvious that obtaining a three-year loan was merely an integrated step in securing the permanent financing to purchase the home. The 8th Circuit’s interpretation indicates that the new loan need only be associated with or in relation to (as opposed to directly related to) the acquisition of the principal residence for the points to be deductible. This rationale should also apply to taxpayers who refinance a bridge loan or construction loan, at least within the jurisdiction of the 8th Circuit (AR, IA, MN, MO, NE, ND, and SD). The IRS has stated that it will not follow the Huntsman decision outside of the 8th Circuit (Action on Decision 1991-02, 2/11/91).

Disclaimer for all except securities related articles

Privacy Statement