Q: This year, my wife and I refinanced the mortgage on our house and paid four points. We have been told that the IRS will not allow us to deduct points paid for refinancing. Is this true?

A: No. You always may deduct as interest points paid for use of the money provided under a mortgage, as long as it is the custom in your area. The question, however, has to do with when the deduction may be claimed.

The total amount of points paid may be deducted in the year of the payment if the funds are used to purchase or improve your residence. On an original mortgage, this requirement is satisfied because you are using the mortgage money to buy your home.

When you refinance, you must use the proceeds to "improve" your home to claim the total amount of the points in the current year. If, as is most often the case, the funds are used for investment or for something such as a child's college tuition, you may not deduct the total all at once.

You still get to claim the interest deduction, but the amount of the points must be considered prepaid interest and must be spread out over the life of the mortgage. Thus, if your refinanced mortgage is for 20 years, you may claim one-twentieth of the total as interest expense in each year.

If you sell the house or repay the mortgage before the end of the 20-year period, you may claim the remaining balance of the points in the year of the payoff.

Q: I have been using the dividends on my public utility stock to buy additional shares, deferring the tax on up to $1,500 in dividends until the stock is sold. If I willed the shares to my heirs, would the estate have to pay income tax on the deferred dividends? Or would my heirs have to pay the tax when they sold the stock, using no tax base (assuming the shares were purchased more than a year ago)?

A: The correct answer is "neither of the above." The estate would have no income-tax liability on the deferred dividends, but the value of the shares would have to be included in your estate for estate tax purposes. (There is an unlimited exclusion from estate tax if the property is left to your spouse; for other heirs, the exclusion this year is $500,000, and it goes up to $600,000 for 1987 and later years.)

When your heirs sold the accumulated shares, they would have to pay tax on any capital gain. But such a gain would be figured over a cost basis of the fair market value on the date of your death, rather than over your zero-cost basis. As a result, under the circumstances you describe, the dividends on which income tax had been deferred would escape income tax entirely; the income never would have to be picked up by anyone for income-tax purposes.

Q: In a recent column, you wrote that a loan to a son that was not repaid could be claimed on Schedule D as a personal bad debt. It is my understanding that bad debts between relatives cannot be deducted. Is this correct? Can you please write in your column and let me know the criteria and handling of bad debts between relatives?

A: A loan to a relative that becomes uncollectible can be deducted as a bad debt on Schedule D of your tax return. Because of the relationship between debtor and creditor, however, you can expect the IRS to take a close look at the transaction; you should be prepared to support your claim with good documentation.

When you make a loan to a relative -- even if you don't expect it to turn bad -- he should provide you with a signed note showing the amount of the loan and the repayment terms, including interest to be charged. (You can get a standard note form at a commercial stationer's.)

In addition, you should have documented evidence of your attempts to obtain repayment -- records of phone calls or personal contacts, copies of letters requesting payment, etc. There is nothing in the tax laws to keep you from deducting a bad debt to a relative, but you do need paperwork to substantiate the tax deduction and to demonstrate that the transaction was a bona fide loan and not a disguised gift.