Those are the basics.

There are rules and guidelines to these deductions, however. Even though Realtors and lenders have the best intentions, sometimes they are a little "fuzzy" about exactly what is deductible.

When most people buy a home, they generally obtain a mortgage. Mortgages have costs and one of those costs is the "loan origination fee." The loan origination fee is usually a percentage of the loan amount, generally expressed as "points."

For example, one "point" on a $150,000 loan would be $1500. One and a half points on the same loan amount would be $2250.

On VA and FHA loans, points are often broken down into two categories: loan origination fee (which is usually one point) and discount points (which are also a percentage of the loan balance). Both are deductible.

The loan origination fee must be expressed as points in order for it to be tax deductible.

When buying a home, points are deductible in the year they are paid, providing they meet certain conditions. The main conditions are that the mortgage is secured by the home you live in most of the time and that you used this mortgage to either purchase or build your home.

However, there are other conditions.

Your lender cannot inflate the points to include other items you would normally be charged. When buying a home, there are normally other charges such as appraisal fee, title insurance fee, property taxes, settlement fees, and so on. If by some miracle you are not charged these fees but your "points" are higher than normal…

In that case you can’t deduct the points. Sorry.

The cash you put into the deal must also exceed the amount charged in points. In other words, if your points were $3000, but you only had to put in $2000 to close, the IRS knows something is up. Your lender is inflating your loan amount to cover your points. Although a lender can technically do this, you wouldn’t be allowed to deduct the points.

The only other major condition is that the points must be clearly stated on the HUD1 Settlement Statement. This is a document you receive after closing that clearly lays out all the costs involved in buying the home. The seller also receives a HUD1.

When purchasing a home, sometimes the buyer negotiates for the seller to pay some closing costs, including the points. Since the seller pays them and not the buyer, one would assume they could not be deductible, right?

Wrong.

If the seller pays the buyer’s points, the Internal Revenue Service allows the buyer to deduct this as an expense on their federal tax returns. However, the seller cannot deduct them, too. Paying the buyer’s closing costs, including points, merely reduces the net gain on the home for purposes in calculating capital gains taxes (which are usually deferred).

Points paid to finance the purchase of a second home must be deducted over the life of the loan, not in the year in which they are paid.

If you make too much money, there are limits on what you can deduct, and for that you should see a Certified Public Accountant. In the year 2000, if your "adjusted gross income" was over $128,950 there is a limit placed on what can be deducted. For married couples filing separately, the figure is half that.

With two exceptions, other closing costs are not deductible. Those exceptions are pre-paid interest and pro-rated property taxes.

When you buy a home, you may close on any day of the month. However, most lenders want their mortgage payment due on the first of each month. So if you close on the 20^th, for example, you "pre-pay" ten days of interest as part of your closing costs. The ten days of interest pays you up to the end of the month. Your first mortgage payment will not be on the first of the following month, but the month after that. Unlike renting, where you pay in advance, mortgages are paid in arrears.

Since interest is a deductible expense, prepaid interest is also deductible.

A similar thing happens with property taxes. The seller’s last property tax payment may have covered part of the time where you will actually be the owner of the home. The settlement agent will calculate how much of that last bill you should pay and charge it to you as a closing cost called "pro-rated property taxes." This is also deductible.

Whenever you reach a point where you begin itemizing deductions, it is best to have your tax returns prepared by a Certified Public Accountant. Internal Revenue Service rules and regulations can quickly become…confusing.