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Mortgage Points

COST OF PLACING A MORTGAGE ON PROPERTY

A mortgagor typically incurs certain costs related to placing a mortgage
upon real property. She may, for instance, be responsible for the payment
of brokers' commissions, title search expenses, appraisal costs, or other
fees for services rendered. Although these costs are not deductible as
expenses in the year paid, they can be amortized on a straight-line basis
over the life of the loan if the loan is made in connection with trade or
business property or property used for the production of income.
Costs of renewing or extending an existing mortgage loan are likewise
recoverable by amortization over the life of the renewed or extended loan.

OBSERVATION: If a pre-loan fee is paid as compensation to a lender
solely for the use or forbearance of money, it is considered prepaid
interest (sometimes referred to as "points" or "loan origination
fees"). Rev. Rul. 69-582, 1969-2 C.B. 29. Although
interest is generally deductible in the year paid, prepaid
interest paid by cash-basis taxpayers must be capitalized unless it
is incurred as part of a loan transaction for the purchase or
improvement of the taxpayer's principal residence.

When a taxpayer no longer bears the burden of a mortgage, a deduction is
allowed for the remaining unamortized costs. Thus, if the property is sold
prior to the date on which the mortgage loan is repaid, the unamortized
costs becomes deductible in full in the year of sale. Similarly, the
balance of unamortized mortgage loan costs is deductible in the year of an
individual mortgagor's death or of a corporate mortgagor's dissolution and
liquidation. Premature discharge of a mortgage loan (e.g., through
prepayment or foreclosure) will also result in the entire unamortized
balance of mortgage costs being deducted in the year of discharge.

EXAMPLE 4: Mike borrows $400,000, repayment of which is secured by a
mortgage against property to be developed as an apartment. Mark paid
$5,000 as a commission for arranging the loan, $1,250 for title
insurance in favor of the lender, and $750 in legal fees (for a total
of $7,000). The life of the loan is ten years. Mike's annual
allowance for amortization of the total cost of the loan is $700, or
one-tenth per year. At the end of three years, Mike sells the
property after deducting a total of $2,100 for mortgage costs in the
previous three years. His deduction for the unamortized balance is
$4,900 (i.e., $7,000 in total mortgage costs minus $2,100 in
deductions previously taken).

Costs associated with the acquisition of a mortgage that are "start-up" or
"pre-opening" expenses (i.e., paid or incurred prior to the commencement
of a trade or business) are also not currently deductible. However,
they too can be amortized over a period of not less than 60 months if
they:

(1) Are paid or incurred in connection with investigating the
creation or acquisition of an active trade or business, creating an
active trade or business, or any activity engaged in for profit or
for the production of income in anticipation of such activity
becoming an active trade or business; and

(2) would be allowable as a deduction if paid or incurred in
connection with the operation of an existing trade or business in the
same field. See Ch. 180 for discussion of the
amortization of start-up expenses.

From the mortgagee's point of view, costs associated with the origination
of a loan are generally deductible as ordinary and necessary business
expenses under Code Section 162. However, the IRS has determined that
"finders fees" paid by lenders to brokers, title companies, and other
third parties for their introduction of acceptable applicants for
mortgage loans must be capitalized and amortized over the lives of the
mortgage loans made to such applicants. Rev. Rul. 57-400. In addition,
costs incurred in the purchase of pre-existing loans from other parties
for resale are also subject to capitalization under Code Section 263A.