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[[ On the back side of form 1098, under Box 1,
there is a Caution that says "If you prepaid
interest in 1998 that accrued in full by
January 15, 1999, this prepaid interest may
be included in box 1. However, even though
the prepaid amount may be included in box 1,
you cannot deduct the prepaid amount in 1998."]]

See what happens when you read things that the rest of the world ignores? It brings up additional questions.

[[ My question is what *exactly* is the definition
of 'prepaid'??? I usually pay before the 1st,
so they received my Jan. 1, 1999
payment in December of 1998. Is the interest
portion of that payment what they are talking
about when they say prepaid interest? Do I have
to deduct some amount from what is reported in
box 1??? ]]

You should be fine. With respect to your mortgage interest, "prepaid" has a specific definition. Here is what IRS Publication 936 has to say about the issue:

"Prepaid interest. Report prepaid interest (other than points) only in the year in which it properly accrues.

Example. Interest received on December 20, 1998, that accrues by December 31 but is not due until February 1, 1999, is reportable on the 1998 Form 1098.

Exception. Interest received during the current year that will properly accrue in full by January 15 of the following year may be considered received in the current year, at your option, and is reportable on Form 1098 for the current year. However, if any part of an interest payment accrues after January 15, then only the amount that properly accrues by December 31 of the current year is reportable on Form 1098 for the current year. For example, if you receive a payment of interest that accrues for the period December 20 through January 20, you cannot report any of the interest that accrues after December 31 for the current year. You must report the interest that accrues after December 31 on Form 1098 for the following year.

[[As a side note, I refinanced my loan 8/21/98.
No points are reported on my 1098, and I don't
think any are shown on my settlement statement?]]

If you PAID points, and they are not on the settlement statement, it would be EXTREMELY unusual. And, in fact, illegal. So you might want to double check your settlement statement more closely.

[[ How can I be sure whether I paid points or not?]]

From your original loan documents and/or the settlement statement. You original loan docs should tell you if you paid points. And if you did, they should be disclosed on the settlement statement.

And you might want to go to the IRS web site and download IRS Publication 936 for additional information on your points deduction.

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