Squeezing in an extra mortgage payment this year could help with your taxes

By mark-slade December 22, 2010

Want to increase the size of your 2010 tax deductions (and i suggest you reach out to your accountant before you do so)? Consider making your upcoming January 2011 mortgage payment while the calendar still reads 2010.

Using The Tax Code To Your Advantage

An “early” payment increases your 2010 tax deductions because of how mortgage interest works within federal tax code.
Unlike rent which is paid in advance at the beginning of a month, interest on a mortgage is always due at the end of the month — after the money’s already been borrowed from the bank.
When you study a mortgage statement, you’ll notice that it’s actually a bill for the interest that built up during the prior 30 days.  January 2011’s mortgage statement, therefore, is a bill for December 2010’s accrued interest.
For a lot of Cincinnati homeowners, that mortgage interest is tax-deductible in the year in which it was paid. So, to boost your 2010 mortgage interest tax deductions, simply pay your January 2011 mortgage statement before the New Year.
Simple, right?

The Caveats Of Timing Your Mortgage Payment

Before you send that January mortgage payment to your servicer early, it’s important to remember that you’re dealing with federal tax code. There’s going to be caveats, exceptions and special cases that impact your eligibility so be sure to review your individual situation with an accountant before moving forward.
The first gotcha of which to be aware is that is not every mortgage is mortgage interest tax deduction-eligible.  The IRS does a pretty good job of outlining mortgage eligibility via this flowchart. You can follow along at-home to make sure your loan qualifies.
The second Good News/Bad News Gotcha is the Alternative Minimum Tax (AMT).  Because of AMT, some filers will find their “normal” tax deductions pared — including some related to the mortgage.  This may reduce or even negate the benefits of making January’s mortgage payment in December, so I strongly urge you to reach out to an accountant if you don’t already use one.
And, lastly, don’t get ambitious.
In the eyes of the IRS, you’re allowed to make January’s mortgage payment in December because the payment is actually due. If you try to pay February in advance as well, you won’t have much to gain. This is because paying February before the mortgage interest has accrued is considered to be a “prepayment” and prepaid mortgage interest is rarely tax-deductible.

There’s 10 Days Left In 2010

If you’re planning to make your January payment early, don’t cut it close.  It’s a popular vacation time and servicers are short-staffed.  Send your payment prior to Christmas, if possible. You want to give your lender ample time to receive and process paperwork.
And, again, talk to your accountant first. The “pay early” plan could be a wasted effort, ultimately, depending on your individual taxpayer profile.
The complete IRS guidance on home mortgage interest tax deductions is available online.