How does the government encourage real estate sales and homeownership? In addition to offering a variety of small incentives, it offers borrowers two big tax breaks: Mortgage interest deduction and property tax deduction.
Here’s how they work. When you take out a loan, both principal and interest comprise your payment. You can deduct the total amount of interest you pay to your mortgage servicer every year from your income. For example, if your total monthly housing payment equals $2,000 and the servicer applies $1,750 toward interest, you can deduct $1,750 for every month that you made a housing payment.
In addition, you can also deduct your property taxes. Many homeowners pay their property taxes by depositing monthly payments with their mortgage servicer, who then deposits the payments into an escrow account. When the property tax bill comes due, the servicer distributes funds from the escrow account directly to the tax assessor. (Many homeowners also pay their property taxes directly to the tax assessor, bypassing escrow.)
Home loan servicers make accounting for these deductions simple by issuing every borrower a 1099 statement at year end. The 1099 tells you exactly how much interest you paid. If you contributed to an escrow account, it tells you how much it distributed to your tax assessor (and your property insurer).
Keep in mind that you can’t deduct every payment that your lender distributes from your escrow account. Property insurance, for example, isn’t deductible. Also, lender rules state that you must keep a “cushion” in your escrow account in case your property taxes rise, so make sure you only deduct payments made on your behalf from the account and not the payments you made to the account.
Finally, don’t forget that “points” is a fancy word for “mortgage interest.” If you paid prepaid points when you closed on your home that expense is deductible. In other words, keep accurate records and let the deductions commence.
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