When you pay your taxes, you don’t have to pay tax on all of your income. The government lets you deduct the higher of either:
- All of your eligible deductions
- or –
- The “standard” deduction for married filers (for YE 2014, this was $12,400 for a married couple, $6200 for single filers, or $9100 for filers as “Head of Household”).
If you file a joint return, look at your 1040 tax return on line 40. If this number is greater than $12,400 (or the standard deduction that applies to you above), you are itemizing deductions. If you are itemizing, when you increase money you pay towards mortgage interest and taxes, this additional expenditure is also going to increase the itemized deductions you can take from your income.
For example, let’s say two people make $100,000 per year, and they pay $12,000 in real estate taxes and mortgage interest each year, with $2000 in other eligible deductions. They actually only pay taxes on $86,000 of their income, since they have $14,000 of deductions.
If this couple increases their mortgage interest and taxes from $12,000 to $15,000, they will have $3000 more in out of pocket costs each year. However, their taxable income will drop from $86,000 to $83,000, because these expenses are 100% deductible from income. If they were paying federal taxes of $13,219 on $86,000 of taxable income, they will only pay $12,469 of tax on $83,000 of income. In effect, they save about $750 of federal taxes to offset the $3000 they are spending, therefore the $3000 actually costs them $2250–once the year-end tax changes are factored into the decision. There is a similar ratio for state income taxes.
The result is that for most people, when they increase spending on interest and real estate taxes, they don’t end up paying the full cost of those increases–as that additional spending amount is deductible from income. Keep in mind that only the interest portion of your mortgage counts toward this math, not the principal amount that is reducing what you owe each month.
Because COAST is not licensed to provide tax advice, we are required to add that you should always check with your own tax professional, to be sure that this general information is applicable to your unique tax circumstances. This should not be interpreted as tax advice, or an interpretation of the tax code.