The timing of deduction has been significantly affected by the taxpayer victory in Huntsman v. Commissioner, and the information contained in IRS Notice 90-70.

GENERAL REQUIREMENTS

Lending institutions often charge points when lending money to a taxpayer acquiring real estate. They are typically charges by the lender when the interest rate that may be charged on an FHA, VA, or Federal Land Bank loan is below the market rate. Other times, a borrower may be given the option of borrowing at a given interest rate or paying loan points and borrowing at a slightly lower rate.

Many charges associated with obtaining a mortgage are payable in advance of the lender granting the loan. However, points are distinguishable from fees charged by the lender for specific services rendered. Because service fees are not for the use of forbearance of money, they do not constitute interest expense. Such nondeductible loan fees include:

* Loan origination fees paid in lieu of specified service charges (e.g., VA loans);

* Loan placement fees paid by a seller in order for the buyer to obtain an FHA mortgage;

* Appraisal fees;

* Credit investigation fees;

* Inspection fees; and

* Recording fees.

When a lender charges a buyer an amount that includes both points and a charge for services rendered, the Tax Court has held that the charge for the services rendered must be substracted from the total charge to determine the points paid. Where the value for the services rendered cannot be determined, the total charge will be nondeductible.

DEDUCTING POINTS IN THE

YEAR OF PAYMENT

In determining the timing of the deduction for points paid in a given year, Sec. 461(g) generally provides that a cash basis taxpayer must treat prepaid interest in the same manner as that of an accrual basis taxpayer. Specifically, both the cash basis and the accrual basis taxpayers are allowed a deduction for the year in which the interest represents a charge for the use or forbearance of money.

However, an exception to the general rule is contained in Sec. 461(g)(2). Under this provision, a cash basis taxpayer can deduct points: 1) paid on indebtedness secured by the principal residence of the taxpayer; 2) paid on indebtedness incurred in connection with the purchase or improvement of the principal residence; 3) for which it is an established business practice in the area in which such indebtedness is incurred; and 4) if the amount of such payment does not exceed the amount generally charged in such area.

As a result, to secure an immediate deduction for points paid, both Sec. 461(g)(2) and the qualified residential interest rules of Sec. 163(h) must be satisfied.

Example 1: On January 1, 1991, Taxpayer A decided to purchase a home for $100,000. After placing a 20% down payment, Taxpayer A borrowed $80,000 from the First National Bank at 10% interest on a 15 year mortgage. In addition, Taxpayer A paid, from separate funds, four loan points. The payment of points is an established business practice in the area in which Taxpayer A lives and does not exceed the amount generally charged in this area.

For 1991, Taxpayer A's deductible points paid in 1991 is $3,200 and will be shown on Schedule A of Form 1040 as a part of his deductible qualified residence interest.

Secured by the Taxpayer's

Principal Residence

The Sec. 461(g)(2) deduction for points in the year paid applies to indebtedness secured by a taxpayer's principal residence. For a cash basis taxpayer, although interest on a loan secured by a second residence is deductible in the year paid, points on a loan secured by a second residence are not; rather, they must be amortized ratably over the life of the loan.

An acceptable method for a cash basis individual to deduct points over the life of the loan is prescribed in Rev. Proc. 87-15. To use this method, the loan must be for a period no greater than 30 years. If the loan is in excess of 10 years, then the terms of the loan must be customary for the area in which the loan is made. No greater than four points can be charged for a loan of 15 years or less (six points for a loan in excess of 15 years).

Under Rev. Proc. 87-15, the amount of points deductible in any given year is computed by 1) dividing the total points (excluding those deductible in the year in which paid) by the total number of periodic payments due over the life of the loan and 2) multiplying the result by the total periodic payments made during the year.

Example 2: Same facts as Example 1, only the points paid relate to a mortgage secured by the taxpayer's second residence, rather than his first residence. Because the $3,200 in points paid do not relate to indebtedness obtained to purchase or improve Taxpayer A's principal residence, points cannot be deducted entirely in 1991. Rather, $213.33 can be deducted each year for 15 years as a part of his qualified residence interest.

What is a Principal Residence?

A definition of a taxpayer's principal residence is not found in the IRC. Thus, whether a taxpayer's residence is his principal residence is a facts and circumstances issue. Where a taxpayer has but one residence, usually it will be construed to be the principal residence. However, a taxpayer may act in a manner such that his home ceases to be considered his residence. In William C. Stolk, a taxpayer moved from his belongings in storage, and lived in the apartment for the two-year period prior to the sale of the home. Based on these facts, the Tax Court ruled that the taxpayer's home could not be claimed as his principal residence because his apartment, rather than his former home, constituted his principal residence.

At any given time, a taxpayer can have no more than one principal residence and the issue of which one is the principal residence must be determined. Reg. Sec. 1.1034-1(c)(3) provides that where a taxpayer purchases his new residence prior to selling the old one, his new residence may be temporarily rented out prior to his vacating his old one. As a result, the temporary renting out of the new residence will not harm its status as the principal residence.

In Connection with the Sale or

Improvement of a Principal

Residence

Determining the deductibility of points paid when refinancing a principal residence raises several issues. The IRS's published position in Rev. Rul. 87-22 is that the taxpayer must deduct the points paid ratably over the remaining loan term, because the points are paid in connection with existing debt rather than paid in connection with the purchase or improvement of a taxpayer's principal residence. If proceeds from the loan are used both for refinancing and for improvements to a principal residence, then a share of the points allocated to the improvement part of the loan can be deducted immediately.

In Huntsman v. Commissioner, the taxpayer purchased a home with a three-year "balloon" payment mortgage. In the next year, he obtained a home improvement loan secured by a second mortgage on the residence. Two and a half years after the purchase of his house, the taxpayer refinanced both loans with a new 30-year mortgage. On his tax return for that year, he deducted the full amount of the points paid in connection with the 30-year loan.

The Tax Court agreed with the IRS's position that the deduction for points paid by the taxpayers should be spread over the life of the loan because the points were not paid "in connection with" the purchase or improvement of the taxpayer's principal residence. On appeal, the Eight Circuit reversed the Tax Court. In so doung, the appeals court cited many of the arguments set forth by Judge Ruwe in his dissenting opinion to the Tax Court's decision. In determining the meaning of the phrase "in connection with" for purposes of Sec. 461(g), Judge Ruwe cited Snow v. Commissioner, in which the Supreme Court gave a broad construction to the phrase "in connection with "for purposes of determining the deductibility of research expenditures incurred prior to the commencement of a taxpayer's business activity under Sec. 174.

As a second rationale for allowing the taxpayer to deduct points paid in the year of refinancing, Judge Ruwe noted:

By inference the words "in connection with' when used as a conjunctive between expenditure and some other term (e.g., a trade or business) means that there can be a temporal hiatus between the two."

Judge Ruwe also noted that the legislative history of Sec. 461(g) indicated that Congress, in enacting tax statutes, has bee quite solicitous of encouraging home ownership.

The Huntsman decision expands the number of situations involving the refinancing of a principal residence where the points paid would qualify for Sec. 461(g) treatment. The fact that the taxpayer originally signed a three-year balloon on his home suggests that he intended to secure long term financing sometime within that period. Taken together, the circumstances surrounding the signing of the original three year balloon note the second mortgage, and the 30-year note ultimately resulted in the taxpayer receiving long term "take-out" financing for his principal residence. As a result of the Huntsman decision, the "in connection with" requirement would appear to be more readily satisfied where it appears that, through the use of refinancing, the taxpayer is responding to market exigencies in acquiring or improving his principal residence.

The Tax Court decision also contains some interesting dicta involving the refinancing of a principal residence. According to the Tax Court, where a construction loan or bridge loan is replaced by more permanent financing upon completion of the residence, Sec. 461(g) would apply to allow an immediate deduction for points paid on the latter financing.

Example 3: On September 1, 1990, Taxpayer B decided to build his own residence. Taxpayer B borrowed money from the bank for seven months; the time within which he expected to finish construction. Taxpayer B paid "prime plus four"--four percentage points over the prime rate of interest. At the end of the seventh month, Taxpayer B negotiated "take- out" financing on his principal residence with the local bank. Taxpayer B borrowed $280,000 for 30 years at an 11% interest rate and paid three loan points. The payment of points is an established business practice in the area in which Taxpayer B lives and does not exceed the amount generally charged in this area. The $8,400 in points will be deductible as qualified residence interest in tax year 1991.

However, while the Eighth Circuit's decision in Huntsman amounts to a taxpayer victory, several caveats should be made. The IRS has recently indicated its non-acquiescence to the result of this decision. As a result, while the Tax Court, under the Golsen rule, is constrained to follow the Huntsman decision for those taxpayers living in the Eighth Circuit, similar cases involving this issue in other jurisdictions probably will be litigated.

Refinancing Because of Falling

Interest Rates

A more important caveat is that the Huntsman decision will have no effect upon the refinancing of the taxpayer's principal residence to take advantage of falling interest rates. Although Hunstman effectively creates a "window of opportunity" in which the taxpayer can deduct points paid upon a properly structured refinancing, points paid to refinance a principal residence to take advantage of falling interest rates are not deductible in the year paid. As a practical matter in most situations, the current interest rate would have to fall at least two percentage points below the taxpayer's existing mortgage loan rate for refinancing to make economic sense.

Example 4: Taxpayer C bought a home for $100,000 on January 1, 1988. He paid $25,000 down and financed the balance with a 30-year mortgage at 11.75%. To take advantage of falling interest rates, C refinanced his original loan on January 1, 1991, at a rate of 9%. He paid $2,000 in loan points. The points paid on the refinancing must be deducted ratably over the life of the loan.

Separate Funds

Another requirement to ensure a deduction for points paid on principal residence indebtedness is that the debtor must pay points from separate funds. In Schubel, the Tax Court held that so-called "prepaid finance charges" were not "paid" during the year in question for purposes of Sec. 461(g)(2), where the lender withheld such charges from the loan proceeds. In essence, the court held that the loan arrangement in Schubel amounted to a discounted loan. Because Sec. 461(g)(2) was not enacted to affect the taxation of discounted loans, the Tax Court held that points must be paid from separate funds in order for the taxpayer to immediately deduct points incurred in connection with the purchase or improvement of a principal residence.

The Demise of the Separate

Funds Requirement?

Sec. 605H(b)(2)(C) of RRA 89 imposed a new home mortgage information reporting requirement upon mortgage lenders. Recently issued IRS Advance Notice 90-70 provides that mortgage lenders must use new Form 1098s to report points that:

* Are charged for the use or forbearance of money;

* Are not in excess of points charged in the market area in which the lender operates;

* Are paid directly by the borrower;

* Are connected with the purchase of the borrower's principal residence where the mortgage loan is secured by such residence; and

* Are paid on closings occurring after December 31, 1990.

All of the conditions must be satisfied before the lender is required to issue Form 1098s. As a result, the lender would not report points paid on second homes, vacation homes, mortgage loan refinancings, home equity loans, and mortgage loans closed prior to January 1, 1991.

Although Notice 90-70 was issued primarily to aid lenders in filing newly required Form 1098s with the IRS, it also provides that points are to be treated as if paid "directly" by a borrower where he or she provides down payments, escrow deposits, and other closing funds at least equal to the total points financed by the mortgage. An IRS spokesman has indicated that the payment of points by separate check is not necessary in this situation.

Example 5: On January 1, 1991, Taxpayer D borrowed $70,000 at 10% for 30 years with four points to purchase his principal residence. The lender subtracted the points from the loan proceeds. Taxpayer D provided a down payment of $10,000. The payment of points is an established business practice in the area in which Taxpayer D lives and the points are reasonable in amount.

Since loan points are withheld, but not paid, under the Tax court's analysis in Schubel, Taxpayer D must amortize the points ratably over the 30-year loan term. However, applying the guidance contained in Notice 90-70, because the $10,000 down payment paid by the borrower exceeds the points withheld, the entire $2,800 in points can be deducted in 1991.

Because a borrower typically will pay the lender at least as much cash as the points financed, as a practical matter, it would appear that as a result of Notice 90-70, the "separate funds" requirement embodied in the Schubel decision has lost much of its vitality. However, given that the Shubel decision is still good law, the safest course of action remains having the taxpayer pay points from separate funds.

TRA 86 and Interest Expense

TRA 86 brought sweeping changes to the deductibility of certain types of interest expense. It recognized five categories of interest expense- -personal, investment, passive, trade or business, and qualified residence. TRA 86 phased out the deductibility of personal interest over a five-year period: beginning in 1991, personal interest will no longer be deductible. Included in this category is consumer interest, interest on an underpayment of tax, and interest that does not fall into any of the other interest expense categories.

As for the investment interest deduction, for those years between 1986 and 1990, the $10,000 amount in excess of a taxpayer's net investment income allowed under prior law has been phased-out. As a result, after 1990 a taxpayer's deductible investment interest expense will be limited to his net investment income.

Example 6: In 1991, Taxpayer E owned four properties, each consisting of a house and a lot. Taxpayer E claimed the first house as his principal residence. Taxpayer E rented out both the second and third houses, but having lived in the second for three weeks, decided to claim it as a second residence for purposes of deducting interest under Sec. 163(h). Taxpayer E actively participated in the rental of the third house and deducted the interest expense on Schedule E of Form 1040.

In 1991, the Taxpayer bought the fourth property--a house on 10 acres of land--as an investment. The property is not held out for rent. Of the $90,000 principal price, the Taxpayer borrowed from the bank $60,000 on a 15-year note at 10 3/4% interest with a down payment of $30,000. In addition, the Taxpayer paid four points. The payment of points is an established business practice in the area in which Taxpayer E lives and does not exceed the amount generally charged in this area.

The $2,400 in points paid will be classified as investment interest subject to the investment interest expense limitation rules applicable in 1991.

Under TRA 86, trade or business interest remains fully deductible. However, to escape classification as passive activity interest, the taxpayer must materially participate in the activity. In addition, the taxpayer's interest in the activity cannot be represented in the form of a limited partnership interest, nor can the interest relate to the acquisition of rental property.

While TRA 86 required the tracing of various categories of interest expense, it left relatively unscathed the deduction for home mortgage interest. A taxpayer can deduct interest on a loan, regardless of its size, closed on or before August 16, 1986 and secured by a "qualified residence." For interest on a loan secured by a qualified residence after August 16, 1986, but before October 14, 1987, a ceiling on the amount of deductible interest applies. This debt could not exceed the lesser of 1) the fair market value of the qualified residence or 2) the sum of a) the taxpayer's cost basis in the qualified residence, b) the cost of capital improvements, and c) the taxpayer's total "qualified indebtedness."

Example 7: Taxpayer F purchased a principal residence 10 years ago for $83,000. Assume that his adjusted tax basis in the residence, computed under Sec. 1034(e), is $50,000. In 1987, Taxpayer F built a large attached garage at a cost of $30,000. Assuming that the balance on his mortgage was $70,000, and the fair market value of the residence was $270,000, Taxpayer F could have borrowed up to $43,000, while fully deducting the interest thereon as qualified residential interest. This amount is computed as follows:

1.FMV$270,000

2.Costbasisinqualified

residence$83,000

Plus:Improvements30,000

Less:Mortgagebalance(70,000)

43,000

Lesserof(1)or(2)=$43,000

For purposes of the above ceiling, the taxpayer's cost basis in the qualified residence could not have been less than the principal balance on any home mortgage existing on August 16, 1986. In addition, "qualified indebtedness" consisted of debt incurred after August 16, 1986, but prior to October 14, 1987, secured by a qualified residence and used to pay for qualified medical expenses or qualified educational expenses.

Example 8: Same facts as Example 7, only assume that Taxpayer E refinanced the mortgage so that its new balance increased from $70,000 to $140,000.

Costbasisin

qualified

residence$83,000

Plus:Improve-

ments30,000

LessMortgage

balance(140,000)

Loanamount

forwhichaninterest

deductionisunavailable$27,000

As a result, Taxpayer F cannot deduct interest on $27,000 of the principal balance of the loan. If, however, the taxpayer paid $20,000 in qualified medical or educational expense, then he would be able to deduct interest on all but $7,000 of the principal balance of the $140,000 loan.

RRA 87

RRA 87 further modified the changes to the mortgage interest rules embodied in Sec. 163(h)(3) of TRA 86.

Under current law, interest on loans secured by the principal residence and by up to one second home is deductible as "qualified residence interest" if the loan constitutes "acquisition indebtedness" or "home mortgage indebtedness." For the debt to be classified as acquisition indebtedness, it must be incurred in acquiring, constructing, or substantially improving a taxpayer's qualified residence, and must be secured by such residence. In any given year, the acquisition indebtedness upon which the interest deduction is based is limited to the lesser of 1) the fair market value of the home or 2) $1,000,000 for taxpayers whose filing status is other than married filing separately ($500,000 for MFS taxpayers). Any debt refinanced after October 13, 1987, is acquisition indebtedness only if it does not exceed the principal balance of the original loan immediately before the refinancing. However, if the amount which exceeds the principal balance is used for substantial home improvements, it is considered acquisition indebtedness.

Acquisition indebtedness is reduced by payments reducing the mortgage loan principal balance, and the only way to increase the acquisition indebtedness is to substantially improve the residence. For a personal residence, indebtedness other than acquisition indebtedness is subject to the limitations imposed by the home equity indebtedness rules. Typically, home equity indebtedness consists of second mortgages or home equity loans which are secured by the primary or secondary residence and are limited to the difference between the principal balance and the fair market value of the home. Under RRA 87, these loans do not have to be earmarked for any particular purpose. However, limitations are placed on the amount upon which the interest may be deducted. The total amount of debt outstanding which is considered home equity indebtedness must not exceed the fair market value of the qualified residence as of the refinancing date less any acquisition indebtedness. The maximum amount of home equity indebtedness is $100,000 ($50,000 for married filing separately). Therefore, the overall limitation for qualifying debt-- both acquisition and home equity indebtedness--upon which home mortgage interest may be deducted is $1,100,000. Any interest on a personal residence relating to debt over that limit is considered personal interest and is not deductible after 1990.

Example 9: In 1988, Taxpayer G filed a joint return. He bought a house for $730,000, with a down payment of $200,000 and a mortgage loan of $530,000 for 30 years at 11.5%. On December 31, 1988, when Taxpayer G's outstanding loan balance was $523,000, he decided to refinance his home for $700,000 in order to make $85,000 of home improvements, with the balance used for personal expenditures.

As a result, for 1988 Taxpayer G's acquisition indebtedness is $608,000 ($523,000 + $85,000) and the remaining $92,000, home equity indebtedness. Total interest on the sum of the acquisition and home equity indebtedness is fully deductible in 1988.

There is a "grandfather" clause for home mortgage debt that existed prior to October 13, 1987. All home mortgage debt financed before that date is considered of whether it is a first mortgage, a second mortgage, or other loan refinancing. If these loans were refinanced on or after October 13, 1987, the interest is fully deductible, so long as the new mortgage balance does not exceed the old balance. If it exceeds the old balance, then the new rules under RRA 87 apply. The $1 million ceiling does not apply to these loans. In addition, the use of the loan proceeds does not matter so long as the "grandfathered" loans are secured by the taxpayer's first or second home. However, if these loans are refinanced, then the $1 million limit does not apply to the extent of the new loan balance in excess of the principal balance immediately before refinancing. The amount of pre-October 13, 1987, loans also reduces the $1 million ceiling on any acquisition indebtedness incurred by the taxpayer on or after October 13, 1987.

THE TECHNICAL AND

MISCELLANEOUS REVENUE

ACT OF 1988

Although RRA 87 amended the rules for deducting qualified residence interest for taxable years beginning after 1987, TAMRA 88 amended these rules for taxable years beginning in 1987.

The TAMRA 88 made the following modifications and additions to Sec. 163:

* Interest on debt secured by a qualified residence to refinance pre- August 17, 1986, debt and which is incurred after August 16, 1986, constitutes qualified residence interest where the principal amount of the refinancing does not exceed that of the pre-August 17, 1986, debt immediately before the refinancing.

* Basis in a qualified residence may be increased by the amount of secured indebtedness incurred in acquiring the other spouse's interest in a qualified residence incident to a divorce or legal separation.

* The fact under local law a security interest is ineffective or its enforceability is restricted does not in and of itself preclude the debt from being treated as secured by the residence.

* Interest on debt secured by the qualified residence of a beneficiary of an estate or trust is generally deductible.

* Where a residence is not rented during the entire tax year, it can be treated as a qualified residence even if the taxpayer does not use it as such for the greater of 14 days or 10% of the time that it is rented.

QUALIFIED RESIDENCE

INTEREST EXPENSE:

ALTERNATIVE MINIMUM TAX

CONSIDERATIONS

TRA 86 brought significant changes to the computation of the alternative minimum tax. It added Sec. 56(e)(1), which provides that an individual taxpayer's "qualified housing interest" is an adjustment when computing alternative minimum taxable income.

As amended by TAMRA 88, under the current AMT rules, a taxpayer can deduct "qualified housing interest" which is qualified residence interest under Sec. 163(h)(3). Interest paid or incurred on indebtedness used to acquire, construct or substantially rehabilitate a principal residence or a "qualified dwelling" is deductible. Examples of a qualified dwelling include a house, apartment, condominium, or non- transient mobile home. However, a boat would not constitute a "qualified dwelling" for AMT purposes.

Although for purposes of computing both the regular income tax and the AMT, the interest expense deduction applies to interest on indebtedness on up to two residences, the two sets of rules are not coextensive. For example, while interest on home equity loans of up to $100,000 used for nonresidential purposes is deductible under the regular income tax interest rules, for AMT purposes, the deductibility of such interest must be determined under the interest tracing rules. In addition, unlike the interest rules for regular income tax purposes, for indebtedness incurred before July 1, 1982, the AMT rules do not explicitly require that the debt must continue to be secured by either the taxpayer's principal or secondary residence so long as the debt was secured, when incurred, by either the taxpayer's principal residence or by a qualified dwelling used by the taxpayer or by any member of his family within the meaning of Sec. 267(c)(4).

POINTS ON A QUALIFIED

RESIDENCE--SPECIAL

SITUATIONS

Given the interplay between Secs. 461(g)(2), 163(h), and 56, a number of situations may arise in which the deductibility of points and the timing of such deduction may be at issue.

Regular Income Tax

Considerations

Under current law, assuming that the requirements of Sec. 461(g)(2) are satisfied, one situation which may arise is that the points may relate to a loan obtained to purchase or substantially improve a taxpayer's principal residence in excess of $1,000,000 (or $500,000 for married filing separately taxpayers). As a result, the points must be allocated between the $1,000,000 (or $500,000) portion of the loan and portion in excess of this amount.

Another situation which may arise is that loan points may be paid in connection with the refinancing of a principal residence. Basically, if the new loan consists of both refinanced debt and non-refinanced debt, the points relating to each portion of the new loan must be separated and analyzed.

Example 10: Taxpayer H and his spouse acquired a principal residence in exchange for $100,000 cash and $1,500,000 purchase money mortgage. Taxpayer H paid a total of three points, or $45,000 in connection with obtaining the mortgage loan. Taxpayer H will be permitted to deduct $30,000 (three points on the $1,000,000) and must deduct the remaining points ($15,000) ratably over the life of the 20-year loan at a rate of $750 per year.

Example 11: In 1988, Taxpayer I acquired a new principal residence paying no points and borrowing $71,000 on a three-year balloon note with a plan to rehabilitate the residence. In 1989, Taxpayer I obtained a loan of $105,000 on the same principal residence in connection with this major capital addition. The proceeds of the new loan will be disbursed to pay off the existing mortgage debt in the amount of $70,000 with the remainder to be disbursed during the construction phase of the addition with a construction cost of $35,000. The total of the new mortgage loan financing is $105,000, and the terms provide for a 20-year repayment schedule and two points to be paid at closing. Assuming the points are properly paid at the time of the loan closing, the taxpayer would, under the Huntsman rationale, be permitted to deduct the points paid on both the $70,000 in refinancing ($1,400) and the $35,000 in construction costs ($700). If the Huntsman rationale is not followed, then the taxpayer will be permitted to deduct the points paid on the construction costs of $35,000 ($700) with the remainder of ($1,400) deducted over the 20-year loan term at $70 per year.

An additional situation which may arise is that the loan is used for purposes other than purchasing or improving the taxpayer's principal residence. As discussed earlier in this article, in this situation, the points would be deducted ratably over the term of the loan.

AMT CONSIDERATIONS

In some situations, a taxpayer may be required to determine the amount of points paid for purposes of computing AMT liability. Typically the deduction for points paid to secure a loan on a qualified residence will be the same for both regular income tax and AMT purposes. However, an exception to this rule exists where the taxpayer's qualified residence interest for regular income tax purposes is not the same amount as his qualified housing interest for AMT purposes.

Example 12: In tax year 1991, Taxpayer J owned a principal residence and a large boat that contained sleeping, cooking, and toilet facilities. He bought his principal residence in 1988 and properly deducted $4,200 in points paid in that year. For 1991, his interest on his principal residence amounted to $5,800. Also in 1991, Taxpayer J bought a boat for $30,000 and paid $4,200 in interest expense excluding one loan point relating to the 15 year $30,000 bank loan.

For regular income tax purposes, the taxpayer's qualified residence interest would be $5,800 + $4,200 + $20. Note that the points on the second residence (the boat) would be amortized over the life of the loan for regular income tax purposes.

For AMT purposes, only the $5,800 interest on the taxpayer's principal residence would be deductible. The interest on the boat does not constitute qualified housing interest.

Another exception to this rule exists when the taxpayer refinances his principal residence but the loan proceeds are not used to improve the principal residence. In this situation, although, for regular income tax purposes, the points relating to the amount of the old loan being refinanced would be amortized, for AMT purposes, such points would be deductible in the year paid. The points relating to the amount of the loan refinancing in excess of the old loan on the taxpayer's principal residence would be amortized ratably over the life of the refinancing for both regular income tax and AMT purposes.

THE FINAL SCORE

Many taxpayers, when acquiring a residence, pay a form of prepaid interest expense known as "points." Usually, it is not difficult to apply Sec. 461(g) to determine both the timing and amount of the interest expense deduction for points paid in acquiring, constructing, or improving a principal residence.

Recent case law and an administrative ruling have added a measure of common sense to some of the murkier requirements of Sec. 461(g). Specifically, the Huntsman decision expanded the circumstances under which a taxpayer can immediately deduct points paid when refinancing his principal residence. In addition, the recently issued IRS Notice 90-70 seems to indicate that, under certain circumstances, the IRS will no longer enforce its requirement that the loan points be paid from separate funds at the time of the loan closing.

In a broader sense, however, in many cases the interplay between IRC Secs. 461(g), 163, and 56 has significantly increased the complexity of determining both the timing and amount of the deduction for points paid in a given year. As a result, taxpayers must proceed with caution in order to maximize their total allowable deductible interest expense.

Bruce M. Bird, JD, MS-Taxation, CPA, is an Associate Professor of Accounting at West Georgia College in Carrollton, Georgia. He has published articles in the Tax Adviser, TAXES--The Tax Magazine, the Journal of Taxation of Investments, and other journals. Mr. Bird is a member of the Tennessee Bar Association and the American Accounting Association.

Steven M. Platau, JD, CPA, is Chairman of the Academic Faculty of Accounting at The University of Tampa. He is a member of the Florida Bar, District of Columbia Bar, American Accounting Association, and the Florida Institute of CPA's. Mr. Platau is an active seminar speaker and has published several articles on related topics.

Carol Appleton is in the final stages of the Masters in Accounting program at the University of South Alabama.