People who are refinancing a home mortgage will find that the IRS doesn't necessarily treat a refinancing as nicely as it does a loan taken to buy a house.
Points, those upfront fees each one of which is equal to 1 percent of the mortgage amount, may not be fully deductible in the year of the refinancing.
To make sure you are handling a refinancing wisely, you may want to pick up a copy of IRS Publication 936, "Home Mortgage Interest Deduction."
But even this may not answer all your questions.
If, for instance, you refinanced a couple of years ago and paid points, you should be amortizing the deduction for those points over the life of the loan.
For a 30-year loan and $3,000 in points, you may deduct $100 (one-thirtieth of $3,000) each year of the loan.
These amortized points are reported on Line 10 of Schedule A, "Itemized Deductions."
Edward J. Seifert, a taxpayer-service specialist in the Philadelphia office of the IRS, recommends that you include a note with your return, explaining when the mortgage was taken out, the value of the points involved, and the number of years over which they are being amortized.
What happens if you have been amortizing points paid in a refinancing and you either refinance again or you sell your home? Taxpayers may have trouble finding the answer to this in the usual IRS publications, and even some IRS employees are stumped by it.
Barry Warhoftig, an agent with the IRS quality-assurance staff in Philadelphia, said that the remaining value of the points from the first refinancing should be deducted in a lump when that loan is paid off. A homeowner would then begin amortizing any points paid for the second refinancing.
For example, if a homeowner refinanced to a 15-year loan on July 1, 1989, and paid $1,500 in points, he or she could have deducted six months' worth of points for 1989, or $50. One year's worth would be one-fifteenth of $1,500, or $100. But not all of that can be deducted, because the loan was not in force for the full year.
After deducting a year's worth of points, or $100, for 1990, the remaining value of the points would be $1,350.
If the homeowner paid off the loan in 1991, perhaps by refinancing it or by selling the house, that $1,350 should be deducted on the 1991 tax return. This is also reported on Line 10 of Schedule A, Itemized Deductions.
Robert J. Dudzinsky, tax manager for BDO Seidman in Philadelphia, suggested attaching a note to your tax return to explain this deduction.
In some refinancing circumstances, a homeowner may not have to amortize the entire value of the points, said Saul Epstein, director of taxes at Ernst & Young in Philadelphia.
As an example, he cited a person who borrows $150,000 to pay off a $100,000 loan and to build a $50,000 home addition. Because one-third of the money is going to improve the home, one-third of the points could be deducted immediately.
Because two-thirds of the money is going to pay off the old loan, two-thirds of the points must be amortized over the life of the loan.
Mr. Epstein also said people who buy houses late in the year need to think carefully about paying points.
A homebuyer might not get any benefit from deducting those points if he or she does not have significant other itemized deductions such as state and local taxes and charitable contributions.
In such a case, the homeowner might be left taking the standard deduction, $3,400 for most single people; $5,700 for most married couples filing jointly, and the value of deducting the points would be lost.
Homeowners also can get into trouble by refinancing for substantially more than the amount of the previous mortgage, if the money is not used to improve the home.
If the extra money taken out exceeds $100,000 ($50,000 if married filing separately), the interest on the excess amount is not deductible.
Finally, the federal government only allows you to deduct interest on mortgages (including your main home and your second home) if the amount of the mortgages totals less than $1 million.