Property taxes can be shifty, slippery expenses. Just when you think you have a handle on how much they are, they can change. If your mortgage payment is PITI -- principal, interest, taxes and insurance -- it means that your lender tacks on a little extra each year, payable in monthly installments, for the taxes and insurance portion. You can claim the tax portion as a deduction on your IRS return if you itemize, but sometimes there can be complications.
How Escrow Works
Your mortgage lender deposits the tax and insurance portion of your monthly mortgage payment, then it pays your homeowners insurance and state, county or municipal taxes from this money on your behalf. This is your escrow. Some lenders allow you to elect this option for certain loans, but with others, it’s mandatory. The extra amount is calculated yearly, so it can only be increased once a year. If your taxes go up during that time, it's possible there will be a shortfall at the end of the year. When this happens, your lender must usually pay the difference itself, although it will probably recapture the money by increasing the tax portion of your mortgage payment next year.
The Portion You Can Deduct
You can still deduct your property taxes if there's a shortfall, but you can't claim all of them. You can only claim what you actually paid, not what your lender contributed if it had to come out of pocket to make up the difference. For example, if you paid $5,000 into escrow over the course of the year, and if your taxes were actually $5,250, you can only claim the $5,000, not the additional $250, even though you'll probably make up that difference in future years. By the same token, if you paid $5,250 into escrow but your taxes were only $5,000, you could only claim $5,000 in deductible property taxes. You might have paid the additional $250, but it didn't go toward taxes. It's still saved in your escrow account.
Another complication involves what actually qualifies as a property tax, at least as far as the Internal Revenue Service is concerned. Qualified property taxes must be based on your home's tax-assessed value, which is typically the case, and the taxes must be assessed at the same rate for all homes in your state, county or municipality. Extra assessments or fees your municipality may charge for trash collection, water supply or improvements to specific municipal property don't qualify.
Finding the Correct Amount
The safest way to calculate what you can actually claim as a deduction is to review the statement your mortgage lender sends you at the end of each year, showing what you paid into escrow and what your lender actually paid in taxes on your behalf. Don't go by your tax bill, because your lender could have contributed some of that. Likewise, don't deduct what you paid into escrow. Your lender might not have paid out all of it in taxes.
Beverly Bird has been writing professionally since 1983. She is the author of several novels including the bestselling "Comes the Rain" and "With Every Breath." Bird also has extensive experience as a paralegal, primarily in the areas of divorce and family law, bankruptcy and estate law. She covers many legal topics in her articles.