The fact that discount points are tax deductible isn’t a secret. Yet, many Florida home buyers still don’t know how to deduct this type of prepaid interest from taxes. The first thing a borrower should be aware of is that these points are tax deductible in the year paid.
The IRS Rules for Deducting Discount Points
As expected, the IRS has established a set of rules Florida home buyers must comply with in order to claim a tax deduction for discount points. Below is a brief description of these rules.
- Discount points can only be deducted by the borrower, regardless of who pays for them.
- The amount paid for the points must reflect the amount regularly charged in Florida.
- The mortgage must be used to buy, build or improve a primary residence.
- The taxpayer must use the cash method of accounting (the taxpayer records income when he receives it, and expenses when he pays them).
- The value of discount points cannot be inflated to include other costs; also, points cannot be used to cover other expenses, such as home appraisal fees, title fees, property taxes, etc.
- The amount the borrower pays at the closing must cover at least the value of discount points. As an example, if a borrower takes out a $200,000 home loan and purchases 2 points, he must put down at least $4,000. If the lender requires a down payment of just $3,000, the borrower can deduct only that amount in the year paid; the rest of $1,000 will be deducted over the life of the loan.
How to Deduct Points from Taxes
Lenders are required by law to send Form 1098 to borrowers. The form must include the amount of interest and discount points home buyers have paid during the tax year. Taxpayers must enter the amount on line 10 of on Schedule A (Form 1040). The lender has no obligation to issue Form 1098 for houses that aren’t considered real property.
For taxpayers with gross income above $152,525 and home buyers with mortgages exceeding $1,000,000 or home equity debt greater than $100,000, the IRS has set some limits on the amount of points that can be deducted. Any taxpayer with gross income below $152,525 can fully deduct points in the year paid, but only if he meets all the conditions mentioned above. The other borrowers might be able to deduct points over the life of the loan.
Another exception to the rule is when lenders don’t include the number of points and the corresponding amount on Form 1098. If the points are listed elsewhere, e.g. among the closing costs, the taxpayer must enter them on line 12 of Schedule A. For additional information, please check 2015 Instructions for Schedule A (Form 1040).
Unlike the discount points paid on conventional mortgages, which can be deducted in the year paid, points paid for refinancing mortgages can only be deducted over the life of the loan. For instance, a borrower who pays $4,000 in points for a 10-year refinance is entitled to deduct $400 per year.
To find out if you can claim a tax deduction for discount points, you can use the IRS’s application. For more information on this topic and other issues relating to the home loan programs available in Florida, we invite you to get in touch with one of our dedicated consultants at North Florida Mortgage.