How do I qualify for real estate tax deductions? Can I deduct prepaid mortgage interest?

You might qualify for real estate tax deductions if you pay mortgage interest in advance for a period that goes beyond the end of the tax year. If so, you must spread this interest over the tax years to which it applies. You can deduct in each year only the interest that qualifies as home mortgage interest for that year.

However, there’s an exception that applies to points. Points are usually prepaid mortgage interest and it is deducted ratably over the term of the mortgage.

You can fully deduct prepaid mortgage interest points in the year you paid them if you meet all of these tests:

  1. Your loan is secured by your main home (not a second home).
  2. Paying points is the normal business practice in the area where the loan was made.
  3. The points weren’t more than the points usually charged in that area.
  4. You use the cash method of accounting. (Most people use the cash method of accounting for individual returns.)
  5. The points weren’t paid in place of amounts that ordinarily are stated separately on the settlement statement, like:
    • Appraisal fees
    • Inspection fees
    • Title fees
    • Attorney fees
    • Property taxes
  6. The funds you provided at or before closing plus any points the seller paid were at least as much as the points charged. You can’t have borrowed these funds from your lender or mortgage broker.
  7. You use the loan to buy or build your main home.
  8. The points were computed as a percentage of the principal amount of the mortgage.
  9. The amount is clearly shown on the settlement statement as points charged for the mortgage. The points can be shown as paid from either your funds or the seller’s.

If you meet all of these tests, you can choose to either fully deduct the points in the year paid, or deduct them over the life of the loan. You can also fully deduct the points paid on a loan to improve your main home if you meet tests 1-6.

You usually can’t deduct points you pay to refinance a mortgage in full in the year you pay them even if the mortgage is for your main home. However, you can fully deduct the part of the points related to the improvement in the year you paid them with your own funds if:

  • You use part of the refinanced mortgage proceeds to improve your main home.
  • You meet the first six tests above.

You can deduct the rest of the points over the life of the loan.

If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. If you refinance the mortgage with the same lender, you can’t deduct any remaining balance of points. Instead, deduct the remaining balance over the term of the new loan.

If you paid real estate taxes through an escrow account, you can only deduct the amount that was actually paid:

  • Out of the account
  • During the year
  • To the taxing authority

Real estate taxes you can deduct are usually any state, local, or foreign taxes on real property. These must be charged for the general public interest.

You can’t deduct taxes for improvements like:

  • Streets
  • Sidewalks
  • Sewer lines

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Calculators

So how much will you get (or owe) this year? That’s the million-dollar question. We happen to have three very useful calculators to help you estimate your refund or balance due.

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