Because of low interest rates and an increase in refinancing activity, a brief dis-cussion on the tax treatment of loan points is in order. “Points” are loan charges, loan placement fees, “discounts,” or additional amounts that must be paid by the borrower in order to obtain financing.

IRS treats amounts paid by cash basis taxpayers as deductible “points” for the taxable year in which they are paid if all of the following requirements are met:

• Computed as percentage of amount borrowed. The amounts must be computed as a percentage of the stated principal amount of the indebtedness incurred by the taxpayer and paid by the borrower.

• Charged under established business practice. The amounts paid must conform to an established business practice of charging points for loans for the acquisition of personal residences in the area in which the residence is located. However, amounts designated as points that are paid in lieu of amounts that are ordinarily stated separately on the settlement statement (e.g., appraisal fees, inspection fees, title fees, attorney fees, property taxes, and mortgage insurance premiums), are not deductible as points.

• Paid for acquisition of principal residence. The amounts must be paid in connection with the acquisition of the taxpayer’s principal residence, and the loan must be secured by that residence.

Refinance points: If you refinance a loan to get a lower interest rate, or for just about any other reason, it’s possible that you’ll get hit with points. These loan points must be deducted (amortized) over the life of the loan. It makes no difference if you actually pay or finance the loan points—they will still be required to be amortized. If the loan is paid off prior to maturity (e.g., the residence is sold and the loan is paid off, or the loan is refinanced), the remaining unamortized balance of the points can be deducted in that year.

Let’s look at an example of amortization. John incurs $1,800 in loan points on July 1, 2002—the closing date of his refinancing escrow. The loan is for a period of 30 years. For the first year, John will deduct $30 in interest expense in the form of amortized points. He makes this computation by taking the amount of the points ($1,800) divided by the length of the loan (30 years). That gives him a result of $60, which represents the annual amortization expense for his interest points. For the first year, John also has to take the annual amount ($60) and divide it by the number of months in the year (12), and multiply that result by the number of months the new loan was in force (six). That gives John a result of $30, which is the interest deduction on his mortgage points for the half-year that the loan was in force.

Home improvement loan points: Points paid on a loan to improve your principal residence are also fully deductible in the year paid if the requirements above are met. However, if you take out a new or additional loan to improve your second residence, then the points you pay need to be amortized over the life of the loan.

You can find additional information in Publication 17—Your Federal Income Tax For Individuals at IRS Web site

Parveen Maheshwari is a Certified Public Accountant. He can be reached at (650) 340-1400 or