POINTS
Tax Break For Home Buyers

How Buyers Get Tax Breaks For Seller-Paid Points

The Internal Revenue Service announced in April 1994 another tax break for home buyers-points paid at closing by sellers can be deducted as a Schedule A mortgage expense by the buyer in the year of purchase. That means buyers who purchased a home after December 31, 1990 may be eligible for this tax write-off. Previously, buyers could deduct only loan origination or discount points they personally paid, not those paid by the seller. This can mean substantial savings for many home buyers. For example, if a seller paid 1 1/2 points on a buyer's $100,000 loan and the buyer is in a 28% tax bracket, the buyer's tax bill could be reduced by $420.

Here's the thinking of the IRS: Because sellers typically expect to be asked by the buyer to pay some of the lender's points, and because many sellers agree to pay points to facilitate a sale, the sales price often is high enough to cover these expected sales costs. The IRS figures most buyers are indirectly paying for seller-paid points anyway.

Do You Meet These Conditions? For buyers to deduct seller-paid points, six conditions must be met:
1. The home purchased must be the buyer's principal residence-not rental or vacation property-and the mortgage loan must be secured by that residence.
2. The settlement sheet must clearly indicate whether the points were paid from the buyer's or seller's funds.
3. The points must be calculated as a percentage of the buyer's mortgage loan amount, not as a percentage of the sales price.
4. The amount paid as points cannot exceed what is normal and customary business practice for the area.
5. The purchaser(s) must be solely responsible for making the mortgage payments.
6. The mortgage loan cannot exceed $1 million.

Not For Everyone
Note: Not all residential real estate transactions meet all the conditions to qualify for the tax break. In some cases, home buyers may be ineligible if the seller was a builder/developer who provided a mortgage rate buydown; the IRS does not consider the cost of a buydown as true points.  Also, homeowners may not take the deduction for points paid for refinancing, or for taking out a home equity loan or home equity line of credit. If eligible for a deduction, these prepaid points generally must be deducted over the life of the loan. These are not "seller-paid" points.
 
What This Means For Sellers
Most accountants say the tax treatment for sellers hasn't changed. Like before, sellers should use the cost of points paid on behalf of the buyer to decrease the "adjusted sales price:" The points then will serve to reduce any gain and, possibly, taxes.
When homeowners sell, gain of up to $500,000 on jointly-filed returns and $250,000 on others is shielded from federal income taxes. They must meet two qualification tests during the five-year period leading up to the sale date: they must have both owned the property for a total of at least two years, and the property must have been their principal residence for a total of at least two years. State income tax rules may or may not follow the federal rules, so state taxes may apply to all gain. Any gain over the $250,000 or $500,000 limits is subject to federal tax at capital gains rates. Note that seller-paid points reduce the buyer's "cost basis" in the residence and, thus, increase the amount of gain when the property is sold.
Since this brief explanation is not intended as tax advice, always
consult your tax professional before filing any return.

Easy-Money Steps To Sniff Out A Deduction
Here's how you can tell if you may qualify for a deduction and possibly a tax refund.
First, did you purchase a principal residence after December 31, 1990 and haven't yet claimed a tax break from that purchase for seller-paid points?
To find out, carefully check your settlement sheet-also referred to as the HUD-1 formwhich should be kept indefinitely as it details charges and fees paid as part of the home sale. Does page 2 of the HUD-1 form clearly indicate the seller paid some or all loan origination or discount points? (It doesn't matter whether you purchased with a VA, FHA, HUD, home builder or conventional mortgage loan. But make sure you exclude any VA funding fees or FHA mortgage insurance fees; these do not qualify as deductible points.)
If you qualify for a deduction in the current year, congratulations! Claim the deduction on

Schedule A.
Before filing an amended return for an earlier year, make sure the 3-year time limit hasn't run out for you to file for a refund. For instance, if you bought in 1994, the amended return is due by April 15, 1998; if you bought in 1995, it's due by April 15, 1999. You usually have three years in which to file an amended Federal income tax return for any reason.
Don't forget to file an amended return for your state to get additional refunds.
Remember: Amending your Federal tax return means the IRS gets 3 more years in which to review your return. If you don't want the IRS to get the chance to take a second look, think twice before filing for a refund.

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