In a last-minute change affecting potentially millions of homebuyers, the IRS is expanding the deductibility of "points" paid on mortgages.
The retroactive change, announced Monday with less than three weeks left in the current filing season, means people who bought homes in 1991, 1992 and 1993 could reap hundreds of dollars by filing amended returns.Points - each equal to 1 percent of the loan - often are charged as fees by mortgage lenders. Until now, the Internal Revenue Service allowed home purchasers to deduct only the points they paid.
Often, homesellers paid all or part of the points on the buyers' behalf, but buyers were not allowed to deduct those. Usually, the sellers simply raised the price of their home by an amount equal to the points they paid.
In effect, sellers acted as middlemen between the buyer and lender. The practice disadvantaged buyers by reducing their tax deduction, but it helped them by reducing their closing costs.
Effective immediately, buyers will be able to deduct all of the points.
"We looked at the transactions and decided there was no difference between the seller paying points and the purchaser paying points," IRS spokesman Wilson Fadley said.
Here's an example of how the change will work:
OLD RULE: The Smiths buy a house from the Joneses and borrow $100,000 from a bank to pay for it. In addition to the mortgage interest, the bank charges three "points" - or $3,000 - as a loan origination fee. The Smiths and Joneses agree to split the points evenly. The Smiths then deduct $1,500 from their income on their tax return.
NEW RULE: Under the same set of facts, the Smiths will be able to deduct $3,000 - the $1,500 they paid and the $1,500 the Joneses paid.
The change affects homes purchased after Dec. 31, 1990.
The IRS advised taxpayers who purchased homes in 1993 and have not yet filed their 1040 forms to deduct the full amount on line 9a of Schedule A, if the points were reported to them by the lender on a Form 1098. If the points weren't reported on a Form 1098, then the taxpayer should deduct them on line 10 of Schedule A.
Individuals who have already filed their tax returns for 1993 or who are entitled to claim an additional deduction for 1991 or 1992 should file amended returns on Form 1040X. They should write "seller-paid points" in the top right-hand corner of the form and attach a copy of their settlement statement, known as a HUD-1.
The 1040X and other federal tax forms can be obtained at most public libraries or by calling the IRS at 1-800-TAX-FORM.
Fadley said the agency did not have an estimate of the number of taxpayers affected by the change or of the revenue loss projected for the government.
But potentially the government owes money to millions of home-owners. Between 4 million and 5 million existing and new homes are sold each year. And the amounts could make it well worth the trouble of filing an amended return.
For instance, in the Smiths' case, they could reduce their taxable income by $1,500 more than previously allowed. If they were in the 28 percent bracket, that would save them $420 in taxes.
Tax preparer William Ceravolo of San Diego protested the last-minute nature of Monday's change and urged taxpayers to file an extension if necessary rather than rushing the preparation of their returns and missing deductions.
"These things are happening all the time," he said. "It's gotten so complex the average person can't take advantage of all their deductions."
The IRS automatically grants four-month extensions to taxpayers filing Form 4868 by April 15. But taxpayers who owe money will be charged interest and a penalty of up to 13 percent at an annual rate.
Monday's change on the deductibility of points does not affect refinancings. Points charged to refinance a mortgage still must be deducted over the life of the loan rather than all at once.
The IRS also advised that deducting seller-financed points can affect the basis of a taxpayers' home when it later is sold. For instance, if the purchase price was $102,000 and the seller paid points totaling $2,000, which the buyer deducted, then the basis of the home, from which capital gains would be figured, is $100,000, not $102,000.