Is Prepaying Your Property Taxes The Right Thing for You?

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Prepaying property taxes can be an effective way to reduce your overall tax burden by maximizing your federal income tax deduction, especially if you are subject to the State and Local Tax (SALT) deduction limit. It is particularly beneficial if you expect to be in a higher tax bracket in the current year compared to the next, or if you simply want the peace of mind of having your housing expenses fully cleared.

However, prepaying might not be the right move if:

- The SALT limit hurts you: The federal SALT deduction is currently capped at $10,000 ($5,000 if married filing separately). If you will easily hit this cap regardless, prepaying won’t yield additional tax benefits.
- You miss out on investment returns: The money used to prepay could potentially earn a higher return if invested elsewhere.
- Your escrow account complicates things: If your mortgage servicer pays your taxes, prepaying can cause administrative errors in your escrow account.
- Your municipality doesn’t allow it: Not all local tax authorities accept or credit prepayments for the upcoming year.

To determine if this strategy makes sense for your financial situation, you should evaluate your current deductions using the Internal Revenue Service and consult your local county tax assessor’s office to confirm their prepayment policies.

Prepaying property taxes related to the current year but due the following year has long been one of the most popular and effective year-end tax-planning strategies. But does it still make sense in 2018?

The answer, for some people, is yes—accelerating this expense will increase their itemized deductions, reducing their tax bills. But for many, particularly those in high-tax states, changes made by the Tax Cuts and Jobs Act (TCJA) eliminate the benefits.

What’s changed?

This section keeps the original guidance focused on what’s changed?.

The TCJA made two changes that affect the viability of this strategy. First, it nearly doubled the standard deduction to $24,000 for married couples filing jointly, $18,000 for heads of household, and $12,000 for singles and married couples filing separately, so fewer taxpayers will itemize.

Second, it placed a $10,000 cap on state and local tax (SALT) deductions, including property taxes plus income or sales taxes.

For property tax prepayment to make sense, two things must happen:

You must itemize (that is, your itemized deductions must exceed the standard deduction), and
Your other SALT expenses for the year must be less than $10,000.

If you don’t itemize, or you’ve already used up your $10,000 limit (on income or sales taxes or on previous property tax installments), accelerating your next property tax installment will provide no benefit.

Example

Joe and Mary, a married couple filing jointly, have incurred $5,000 in state income taxes, $5,000 in property taxes, $18,000 in qualified mortgage interest, and $4,000 in charitable donations, for itemized deductions totaling $32,000. Their next installment of 2018 property taxes, $5,000, is due in the spring of 2019.

They’ve already reached the $10,000 SALT limit, so prepaying property taxes won’t reduce their tax bill.

Now suppose they live in a state with no income tax. In that case, prepayment would potentially make sense because it would be within the SALT limit and would increase their 2018 itemized deductions.

Do Your Research

Before you prepay property taxes, review your situation carefully to be sure it will provide a tax benefit. And keep in mind that, just because prepayment will increase your 2018 itemized deductions, it doesn’t necessarily mean that’s the best strategy.

For example, if you expect to be in a higher tax bracket in 2019, paying property taxes when due will likely produce a greater benefit over the two-year period.

How Can the SALT Deduction Help Your Mortgage Payment?

The SALT deduction allows taxpayers to deduct state and local taxes—such as property taxes and state income taxes—on their federal tax return. Prior to 2018, there was no cap on this deduction, but the Tax Cuts and Jobs Act (TCJA) introduced a $10,000 limit for individuals and married couples filing jointly.

Lower Taxable Income = More Take-Home Pay
By maximizing your SALT deduction, you reduce your taxable income, which can lower your overall federal tax liability. This means you may keep more of your earnings, helping free up cash flow for your monthly mortgage payment.
Boosting Affordability in High-Tax States
Homeowners in states with high property taxes—such as California, New York, and New Jersey—are particularly impacted by the SALT cap. While $10,000 may not cover all of your property and state income taxes, it still provides relief that can help offset some of your housing costs.
Strategic Prepayment of Property Taxes
Some homeowners prepay property taxes to ensure they hit the $10,000 SALT cap annually. This approach can be especially helpful if your property tax bill is below the cap, allowing you to fully benefit from the deduction each year.
Planning for Refinancing or Home Purchases
If you’re considering refinancing your mortgage or buying a new home, factoring in the SALT deduction can help you better estimate your tax benefits and overall affordability.

Who Benefits the Most?

Homeowners in high-tax states who itemize deductions.
Those with state income taxes and property taxes that exceed the standard deduction threshold.
Buyers and homeowners seeking ways to offset housing expenses.

How to Maximize Your Deduction

When it comes to mortgage interest payments, you’re sitting on a potential goldmine of tax deductions, but are you truly maximizing your benefits? Understanding the difference between itemizing and taking the standard deduction is just the start. You also need to contemplate how timing your payments and the impact of refinancing can play an essential role.

Keeping accurate records is indispensable, but what specific documents should you focus on? The answers could lead to significant savings, and you might find strategies you hadn’t even pondered yet.

Understanding Mortgage Interest Deductions

When it comes to understanding mortgage interest deductions, you’ll want to grasp how they can profoundly impact your tax returns. By ensuring you’re familiar with the mortgage interest calculation, you can take advantage of the benefits it offers. Fundamentally, the IRS allows you to deduct interest paid on a qualified home loan, which can reduce your taxable income greatly.

To qualify for this deduction, you’ll need to meet certain deductibility requirements. First, the mortgage must be secured by your primary residence or a second home. Additionally, the loan must be used to buy, build, or significantly improve the property. It’s vital to keep accurate records of your mortgage interest payments throughout the year, as these figures will be indispensable for your tax filing.

You should also be aware of the loan limits set by the IRS. For loans taken out after December 15, 2017, interest on mortgages up to $750,000 is generally deductible. Knowing these details can help you maximize your mortgage interest deduction and minimize your tax liability. Take the time to understand these aspects, and you’ll be in a better position during tax season.

Timing Your Payments Effectively

Timing your mortgage payments effectively can have a significant impact on your financial situation. By understanding payment timing, you can maximize your mortgage interest deduction and potentially save money.

End-of-Year Payments: If you’re close to the end of the year and haven’t maximized your deduction, consider making an extra mortgage payment. This can help you deduct more interest for that tax year.
Pay Early in the Month: Making your payment early in the month can guarantee that the interest is calculated on a larger amount for that month, which may provide a better deduction.
Contemplate Your Tax Bracket: If you anticipate moving to a higher tax bracket, timing your payments to coincide with the current year can allow you to benefit from a larger deduction while in the lower bracket.
Monitor Changes in Rates: Stay informed about interest rate changes. If rates are rising, it might be wise to pay your mortgage early to lock in a larger deduction based on lower interest payments.

Refinancing and Its Impact

Refinancing your mortgage can substantially affect your financial landscape, offering a chance to lower your monthly payments or adjust your loan terms. However, it’s pivotal to understand the refinancing costs involved, such as application fees, appraisal fees, and closing costs. These expenses can add up quickly, making it essential to calculate whether the long-term savings outweigh these initial costs.

When you refinance, you might also encounter specific refinancing tax implications. For instance, if you take out a new loan to pay off your existing mortgage, you can generally deduct the interest on that new loan, provided it’s used to buy, build, or substantially improve your home. However, if you’re refinancing for cash-out purposes, the rules change slightly. You’ll want to keep in mind that only the portion of the loan used for your home’s improvement is eligible for interest deduction.

Keeping Accurate Records

Keeping track of your mortgage-related documents is vital for managing your finances effectively. By organizing paperwork and maintaining documentation, you’ll not only simplify your tax preparation but also make certain you don’t miss out on potential deductions.

Mortgage Statements: These documents show your interest payments each year, which are essential for your tax deduction.
Closing Documents: Keep your settlement statement and any closing disclosures, as they might contain relevant information for your mortgage interest deduction.
Property Tax Statements: Since property taxes are often tied to your mortgage, maintaining these records can assist in your overall financial planning.
Refinancing Documents: If you’ve refinanced your mortgage, keep all related paperwork, as it can affect your interest deductions.

Final Words

Homeownership isn’t just about having a place to call home—it also comes with valuable tax benefits that can save you money each year. Whether it’s deducting mortgage interest, property taxes, PMI, or home improvements, these tax breaks can help you keep more of your hard-earned money.