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Seller-paid mortgage points deductible.

The Internal Revenue Service has changed its position on the deductibility of mortgage points. According to revenue procedure 94-27, effective for taxable years beginning after December 31, 1990, home buyers may deduct mortgage points currently even if the points are paid by the seller of the property--as long as they reduce the property's cost basis by the amount of the seller-paid points.

Prepaid interest usually must be capitalized and deducted over the life of a loan. However, Internal Revenue Code section 461(g)(2) allows a current deduction for points paid on debts incurred to purchase or improve (and on debts secured by) a taxpayer's principal residence. The payment of points must be an established business practice in the area in which the debt is incurred and be consistent with the amount generally charged there. If the amounts designated as points are disguised as appraisal fees, inspection fees, title fees, attorney's fees or property taxes, they are not deductible.

Previously, under revenue procedure 92-12 buyers had to pay points themselves to obtain a current deduction. If a seller agreed to pay all or some of a buyer's points, the seller-paid points were not deductible.

Example: Pat buys a house for $500,000. She borrows $400,000 and is charged two points, which the seller agrees to pay. Under revenue procedure 94-27, Pat gets a current interest deduction of $8,000 but must reduce the house's cost basis to $492,000. (For taxpayers who bought a residence after December 31, 1990, but before April 4, 1994, the basis reduction is required only if the buyer deducts the seller-paid points.

The new rule does not apply to loans made to improve a principal residence or to purchase a second home or vacation, investment or business property. Points paid on a refinanced loan, home equity loan or line of credit are not currently deductible even if the debt is secured by a principal residence.

Observation: Affected taxpayers should file amended returns for 1991, 1992 and 1993. To obtain a refund, taxpayers should write "seller-paid points" in the top right margin of form 1040X and attach a copy of form HUD-1 or a settlement statement to the amended return.

--Michael Lynch, CPA, Esq., assistant professor of accounting at Bryant College, Smithfield, Rhode Island.
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Author:Lynch, Michael F.
Publication:Journal of Accountancy
Article Type:Brief Article
Date:Aug 1, 1994
Words:379
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