You probably already knew that mortgage interest was tax deductible, but did you know that an origination fee may be as well? Depending on the situation, you may be able to deduct all of the origination fee right away or over time.
Keep in mind that the following is a rundown of just the basics. Be sure to check with a qualified CPA to see how the rules may apply to your situation.
So, What Is An Origination Fee?
Origination fees are charged by the lender to cover in-house services like underwriting, document preparation, loan processing, funding, etc. Origination fees basically help cover lender overhead and pad the bottom line.
Origination fees may also include points, which are charges for a given interest rate expressed as a percentage of loan amount. For example, if you are borrowing $200,000, 1 point would equal 1% of the loan amount, or $2,000. The IRS views points as prepaid mortgage interest, so they likely will be deductible on your income tax returns.
When Points Are Fully Deductible In the Same Tax Year
Points paid for a mortgage used to purchase or improve a primary residence are entirely deductible in the same tax year you paid them. If you purchase a house, you can deduct the full amount of the points in the same tax year.
If you refinanced and used some of the mortgage proceeds to improve your home, you can fully deduct a proportional part of the points in the tax year you paid them. For example, if you refinanced for cash out and used half the mortgage proceeds to fix up your house, you can deduct half the points on your taxes in that year. Make sure you document carefully the repairs and upgrades you did to your home. The IRS will want to see proof of the upgrades if they ever audit you.
The part of the points not fully deductible in the same tax year has to be handled as described below.
When Points Are Deductible Over the Life of the Loan
Points paid for a refinance (assuming the loan isn’t used for home improvements) on a primary home, second home, investment property, or for the purchase of a second home or investment property, are deducted over the life of the loan.
To calculate how much you can deduct, simply divide the total dollar amount of the points by the total number of payments for the loan (for example, 360 for a 30-year loan, 180 for a 51-year loan, etc.), then multiply by the number of months you had the loan during the given tax year. For example, if you paid $4,000 worth of points for a 20-year fixed loan and had the loan for 9 months during the first tax year (the loan funded in April, which means you had it for nine months of the year), you can deduct $150 (($4,000/240) * 9) for that year. The following year you can deduct $200 because you will have had the loan for the full 12 months of the year (($4,000/240) * 12).
If you pay off the mortgage ahead of schedule, you can take whatever is left to deduct in the tax year the mortgage is paid in full. Check out the following from the IRS website:
If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. However, if you refinance the mortgage with the same lender, you cannot deduct any remaining balance of spread points. Instead, deduct the remaining balance over the term of the new loan. A mortgage may end early due to a prepayment, refinancing, foreclosure, or similar event.
Prepayment Penalties Can Be Deductible
If you pay a prepayment penalty as part of a refinance, you may be able to deduct that as well because it’s often considered mortgage interest. Be sure to check with your accountant on this.
Consult with a Tax Professional
Again, this only covers the basics. There are plenty of rules that can apply, so be sure to check with a qualified tax professional to determine when and how points can be deducted on your taxes.