IRS Called Unlikely to Reverse Restrictions on Deducting Points

Prospects that the Internal Revenue Service will reverse a rule that severely restricts tax deductions for homeowners who refinance their mortgages appear to be diminishing, congressional and industry sources say.

The IRS recently reaffirmed an earlier decision on the rule, while legislation that would reverse the agency’s ruling is stalled in Congress amid concern about the federal budget deficit.

Until 1986, homeowners were permitted to deduct refinancing points in the year in which the transaction took place. One point equals 1% of the loan amount. Points are up-front interest paid at the time the loan is settled.

Amortizing Deduction

Now the IRS has ruled that such points must be deducted over the life of the mortgage. That means that if the loan is amortized over 30 years, the taxpayer is allowed to deduct one-thirtieth of the points each year for 30 years.

The only exceptions are points on any portion of a loan used for improvements on the taxpayer’s principal residence, which may be deducted immediately. For a homeowner who refinances an existing $80,000 mortgage with a new $100,000 loan, taking out $20,000 in equity to spend on home improvements, for example, the IRS would allow the homeowner to deduct only 20% of the points immediately. The remaining 80% of the points would have to be deducted over the life of the loan.

Most owners who refinance do so to get a lower interest rate. Declining rates in the past two years have sparked an avalanche of refinancings, with an estimated 1.85 million loans refinanced last year. That amounted to $150 billion worth of new mortgages, about 2 1/2 times the $61.5 billion refinanced in 1985, according to the Mortgage Bankers Assn. of America. The organization said borrowers typically paid between 2.5 and 3 points.

Losses for Homeowners

The ruling on refinancing points could mean sizable losses in the value of homeowners’ tax deductions, according to John A. Tuccillo, chief economist for the National Assn. of Realtors.

As an example, Tuccillo estimated that a $100,000, 30-year, fixed-rate mortgage at 9 1/2% interest and carrying three points would give the buyer a $3,000 tax deduction resulting in a tax saving of $840 if the value of the points were deducted in the first year.

Using 1986 dollars and estimates of inflation and other economic changes in the next three decades, Tuccillo said the tax deduction would drop to $973.63 and the tax saving to $272.62 if the points were deducted over 30 years.

Sale of Refinanced Home

An owner who sells his or her home after a refinancing and buys a more expensive residence will lose any remaining point deductions at the time of the sale, said Tuccillo.

Bills that would permit continued deduction of all points in the year they are paid have attracted about 180 co-sponsors in the House and 16 in the Senate.