If you keep refinancing, points paid are a tax break

By Sandra Block
USA Today

The decline in home mortgage rates has spawned a new breed of homeowner: the serial refinancer.

But in their zeal to lock in the lowest mortgage rate on the planet, many serial refinancers may be unaware of a potentially lucrative tax break for homeowners who refinance a second or third time.

The tax break involves points, also known as loan discounts or origination fees, which are paid at settlement. One point represents 1 percent of your mortgage loan.

On a first mortgage to buy a primary residence, points are deductible in the year they're paid.

But when you refinance, you're required to amortize the points over the life of the loan. If you paid one point to refinance a $200,000, 30-year mortgage, you would be allowed to deduct only $66.67 a year.

If you decide to refinance a second time, you may be allowed to deduct the amount of unamortized points the year you refinance, says Bob Walters, senior vice president for Quicken Loans.

Suppose you refinanced a $200,000 loan two years ago and paid one point. Using the amortization schedule, you deducted $66.67 last year. Rates fall further, so you refinance again. When you file your taxes for the year you refinanced — in this example, 2003 — you deduct the remaining $1,933.

Deductions for unamortized points must meet IRS rules.

• You can't deduct the balance of your points if you refinance with the same lender. In that case, you must deduct the remaining balance over the term of your new loan.

• The break is limited to your primary residence. Points on a mortgage for a second home must always be amortized, whether it's a first loan or refinancing, says John Battaglia, a director at accounting firm Deloitte & Touche.

Points are deductible because they're considered prepaid interest on a home mortgage. Your settlement statement should clearly state that points were paid on the loan.

Even if you're new at the refinancing game, you should know about other potential tax breaks:

• If you refinance and use part of the money to fix up your home, you can deduct the percentage of the points related to those costs in the year you refinance, Battaglia says.

Suppose you refinance your mortgage with a 15-year, $100,000 loan. To lock in a low rate, you pay two points, or $2,000. You use $75,000 to repay your existing mortgage and $25,000 to renovate your kitchen. Your home improvement costs represent 25 percent of mortgage proceeds, so you can deduct 25 percent of your points, or $500, in the year you refinance. The balance must be amortized over the life of the loan.

• If you pay off your mortgage early, you can deduct any unamortized points in the year the mortgage is retired, the IRS says.

• If you're hit with a prepayment penalty for paying off your mortgage early, the fee is deductible, says Fred Grant, senior tax analyst for Intuit. Penalties for making a late payment on your mortgage are also deductible. These penalties should be listed on Form 1098, the annual tax document provided by your mortgage lender, Grant says.