Keep in mind that points paid by a borrower can be canceled during the year paid when a loan is taken out to purchase or improve a principal residence and when the loan is secured by that principal residence. If an individual has more than one residence, the principal residence is the one lived in most of the year.
There are many standards to be met in order for an individual to obtain a full deduction. First, points must be paid with separate funds, which are not received from the lender. Payment of points also must be an established practice in the geographical location where the loan is obtained, and points paid by the borrower cannot be greater than normal charges in that area. Otherwise, a deduction allowed in the year a borrower pays points will be limited to an area's normal charges. The amount paid beyond the area norm for points then would be deducted ratably over the life of the mortgage.
The IRS position on points paid to refinance an existing home mortgage loan in repayment of the previous debt is that these points are not deductible in the year paid. Also, if a taxpayer is refinancing a short-term loan secured by a mortgage into a long-term financing arrangement, the Court held, points paid qualify as deductions in the year paid, as long as the situation meets the criteria previously discussed.
Refinancing an existing home mortgage loan usually does not qualify for the exception, and points paid must be deducted ratably over the period of the loan. The IRS feels that refinancing is generally done to achieve some financial savings, rather than for purchasing or improving a principal residence.
Remember that interest in the form of points paid by a borrower to purchase or improve a home usually is deductible. All facts of a situation must be examined in order to determine the timing of an allowable deduction. Sound planning in the purchase of a principal residence can give a taxpayer the choice of deducting points either in the year paid or ratably over the life of the mortgage.