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Home buyers may deduct seller-paid points.

The IRS has announced in Rev. Proc. 94-27 that individuals may claim a deduction for "points" paid in connection with the purchase of their principal residence, even if the points are paid by the seller of the property on their behalf. This change in policy was taken, according to the Service, to minimize possible disputes over the deductibility of points. Thus, as a matter of administrative practice, the IRS will treat as deductible points any amounts paid by cash basis taxpayers if the requirements of Rev. Proc. 94-27 are met.

The Service views the transaction as if the seller paid the points to the buyer, who in turn is treated as having used the cash to pay the points charged by the lender. As a result, the buyer must reduce the purchase price of the home by the amount of the seller-paid points. This view comports with proposed Sec. 6050H regulations concerning the lender's responsibility to report points charged to the borrower on Form 1098, Mortgage Interest Statement.

In order to qualify as deductible points, Rev. Proc. 94-27 requires that the amount:

1. Is clearly designated on the Uniform Settlement Statement (e.g., the Form HUD-1) as points (for example, as loan origination fees (including amounts so designated on VA and FHA loans), loan discount, discount points or points), regardless of whether shown as paid from the borrower's or the seller's funds at settlement;

2. Is computed as a percentage of the stated principal amount of the indebtedness;

3. Conforms to an established practice of charging points in the area in which the loan is issued; does not exceed the amount generally charged in the area; and is not being charged in lieu of amounts ordinarily stated separately on the settlement sheet (such as appraisal fees, inspection fees, title fees, attorney fees and property taxes);

4. Is paid in connection with the acquisition of the borrower's principal residence and such residence secures the loan; and

5. Is "paid directly" by the borrower. An amount is considered paid directly if it is provided by the borrower from funds (which may include down payments, escrow deposits, earnest money applied at closing and other funds actually paid over at or before the loan closing) that have not been borrowed from the lender of record. In addition, points paid by the seller (including points charged to the seller) will be treated as paid directly by the borrower, provided the borrower subtracts such points from the purchase price of the residence.

The revenue procedure does not apply to points paid in connection with the acquisition of a principal residence to the extent the amount is allocable to debt incurred in excess of the $1 million limitation under Sec. 163(h)(3)(B)(ii). Other exclusions include points paid in connection with home improvement loans, second homes, vacation homes, investment property or business property. Also excluded are points paid on a refinancing loan, home equity loan or line of credit, even though the indebtedness is secured by a principal residence.

The new rule is effective for points paid by cash basis taxpayers during tax years beginning after Dec. 31, 1990; amended returns can be filed for 1991 and 1992 in order to claim a deduction for seller-paid points not previously deducted. Taxpayers should write "Seller-Paid Points" in the top right margin of the amended return, and should attach a copy of the applicable Form HUD-1 (or other settlement statement) that supports the deduction claimed. Taxpayers may claim a deduction on their 1993 returns by including the amount of seller-paid points on line 9a or 10 (whichever one applies) of Schedule A of Form 1040.

The requirement that the buyer adjust his basis in the principal residence by the amount of deductible seller-paid points is mandatory. However, taxpayers who purchased their homes after 1991 and before Apr. 4, 1994 can avoid the basis reduction requirement if a deduction is not claimed for the seller-paid points.

Note: Lenders are not required to report on Form 1098 the amount of seller-paid points received by them before Jan. 1, 1995. Some lenders, however, may have started reporting such points for 1994 calendar-year transactions based on the proposed effective date of the Sec. 6050H regulations.
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Author:Friedman, Steven M.
Publication:The Tax Adviser
Date:Jun 1, 1994
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