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An Easy Way to Deduct Extra Income This Year!

Published by Hamilton Software, Inc. on June 20, 2015 | Comments

It happens to everyone at some point in their lives: you have an unexpected windfall or other taxable event that temporarily throws your income into upper-level tax brackets for a single year with no offsetting deductions. A deduction, even if pulled from future years, would shelter that income from high tax rates and save you money now and over the long term. Most people are unaware that a simple way to claim a large deduction this year exists for many homeowners.

As a homeowner, you probably file a Schedule A to deduct mortgage interest, taxes, and other deductible expenses. The IRS doesn’t set limits on the amount of these expenses, except that they must have been paid by you during the tax year. It’s generally not possible, or practical, to increase the amount of these expenses in any given year, but one of these—your real estate property tax—may be surprisingly flexible.

You will owe your local government (usually your county) real estate property tax every year you own your home. If you expect to own your home for ten years, and you’re paying $2000 a year in property tax, you can expect to pay the county $20,000 over the next decade in property taxes. While your county only requires you pay minimum yearly payments, many counties allow you to prepay future tax any given year and retain it in an account to be used toward future property tax bills. The IRS allows you to deduct real estate tax you paid during the tax year. That means you may be able to pay $4,000 in property taxes to your county this year, claim it as a deductible expense on this year’s return, and you won’t owe your county property tax for the next two years.

Of course, if you don’t pay property tax for the next two years, you’ll lose that deduction for each of those years. But if you’re normally in the 15% tax bracket and your windfall income puts you in the 25% bracket, it may save you significant money in the long run to claim the deduction now. It’s also possible that without your normal property tax deduction in those future years, you’ll be better off taking the standard deduction in those years, which could save you even more. In fact, it’s a common strategy to alternate years in which you itemize (taking the standard deduction every other year), paying two years’ worth of property tax in the years you itemize.

If your property tax is paid by your mortgage holder, you’ll need to coordinate any prepayments with them first. Mortgage holders typically collect your property tax from you in your monthly mortgage payment and hold it in an escrow account, which they then use to pay your tax to the county. In order to get a deduction for extra property tax, you must pay the tax to the county, not to your mortgage holder. That means you’ll need to instruct your mortgage holder to stop collecting property tax in your monthly payments and allow you to pay your own property tax.

Only non-business real estate tax can be deducted on your Schedule A, however if you own rental property, you can claim prepaid property taxes as a business expense. Be forewarned that if you sell your home (or rental property) earlier than you expected, the county will refund any excess property tax you paid, which you will have to claim as income if you used it as a deduction in a prior year.

Check with your tax advisor and do the math before making the decision to prepay real estate property tax. But whether it makes sense this year or not, it’s always good to have another tool in your toolkit for minimizing the taxes you pay to the IRS.


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