Tax Court Holds that Points Paid on Interest Only Refinancing Not Deductible

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This week in Singh v Commissioner the Tax Court in a summary opinion held that a taxpayer was not entitled to deduct the amounts paid in respect of points on a refinancing of a principal residence. Determining whether interest on a home is deductible is complicated by the reality that for many taxpayers information returns or settlement statements may not completely or accurately indicate the amount that can be deducted.

One such issue relates to when consumers are paying interest on a modified mortgage; as we have discussed before (see. e.g. a guest post by Dave Vendler discussing the issue and related litigation) the Form 1098 that most financial institutions issue does not reflect the amounts that were attributable to the accrued but unpaid interest at the time of the modification. This is an issue that is currently the subject of an IRS guidance project (a copy of the American Bankers Association and Mortgage Bankers Association comments on the proposed guidance can be found here). [As an aside I will moderate a panel discussion on that topic at the ABA Tax Section May meeting in DC as part of the Individual and Family Committee].

Singh does not involve a modified mortgage though does spin off of some of the challenges that many Americans faced following the great recession. In Singh the taxpayer refinanced two mortgages on his principal residence with an interest only loan that was for an indefinite period.

Part of the costs that Singh paid included points on the interest only refinancing. To the extent that the points represent interest taxpayers may deduct the points over the course of the loan (assuming of course that the interest is otherwise deductible). This sweeps in Section 461(g), which requires a cash basis taxpayer to amortize prepaid interest over the life of the loan, just as if the taxpayer were on the accrual method of accounting. Section 461(g)(2) provides an exception to the amortization requirement in 461(g)(1) and allows a taxpayer to deduct the payment of certain points if they were paid “in connection with the purchase or improvement of, and secured by, the principal residence of the taxpayer.”

For taxpayers who seek to refinance years after the original purchase or who do not use proceeds of a refinancing to substantially improve the residence, the immediate deduction exception in Section 461(g)(2) provides no help. When is a refinancing close enough to the original purchase to be eligible for the 461(g)(2) immediate deduction? There is a well-known 8th Circuit case from 1990, Huntsman v Commissioner, that provides guidance for taxpayers seeking a deduction for points. In Hunstman, the 8th Circuit allowed an immediate deduction, emphasizing that the taxpayer refinanced to extinguish short-term loans from the original purchase, rather than just seeking to get a lower interest rate or accomplish other financial goals. That connection in Hunstman allowed the taxpayer to take advantage of the Section 461(g)(2) exception on the points paid on the refinancing.

This brings us back to Singh. A refinancing arising (and points paid on that refinancing) many years after the original purchase differs from Huntsman. In addition, the Tax Court noted that Singh could not deduct the points even under the general Section 461(g)(1) authority, which treats the points as amortized over the life of the loan, as Singh’s loan was for an interest only loan for an indefinite period.

The upshot for Singh was no deduction, and accuracy-related penalties for good measure. This is a a good reminder that the deductibility of interest on residences is sometimes not just a matter of plugging in information off a form 1098 or settlement document.  I suspect there is a great deal of confusion and error in this area of the tax law.

Leslie Book About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

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