Deducting Texas Property Taxes: Escrow, Timing, Rentals, and the SALT Cap

Ask a Texan what they pay in state tax and you will hear about property taxes. They are the price of no income tax, and in much of DFW they are large. The federal return gives some of that back if you itemize. The rules are simple on paper. The mistakes are mostly about timing and about mixing up personal and business property.

The basic rule

IRC 164(a)(1) allows a deduction for state and local real property taxes in the year paid, for cash method individuals. Real property taxes are taxes imposed on interests in real property and levied for the general public welfare. Your county appraisal district values the property, and the county, city, school district, and other taxing units levy taxes on that value. Those are deductible real property taxes.

Not everything on the bill is deductible. IRC 164(c)(1) denies a deduction for assessments for local benefits that tend to increase the value of the property, such as a charge for new sidewalks or streets in front of your home, except to the extent allocable to maintenance or interest. Itemized charges for services, like a flat trash fee, are generally not taxes at all. Homeowners association dues are not taxes.

Timing: the January 31 problem

Texas property tax bills generally go out in the fall, and the taxes are generally due by January 31 of the following year. That calendar creates a choice. A homeowner who pays in December deducts the tax on that year's return. One who pays in January deducts it the next year.

Paying in December is allowed when the tax has been assessed and billed. What is not allowed is prepaying a future year's tax that has not yet been assessed. The IRS addressed this when the SALT cap first took effect: a prepayment of real property tax is deductible only if the tax was assessed and paid in the year claimed.

Timing can matter more now that the cap changes each year. Bunching two years of property tax into one year can push itemized deductions above the standard deduction in that year. It can also push your state and local taxes above the cap, which wastes the extra. Run the numbers before December.

Escrow accounts and Form 1098

Most Texas homeowners with a mortgage pay property taxes through escrow. You deduct the amount the lender actually paid to the taxing units during the year, not the amount you deposited into escrow. Those are often different, especially in a year with an escrow shortage or a refinance.

Many lenders report property taxes paid from escrow on Form 1098, often in the box for real estate taxes paid. If your lender does not show it, your escrow analysis statement or the county's payment history will. The county tax office's online records are the cleanest proof if the IRS asks.

Buying or selling during the year adds one more step. IRC 164(d) apportions the year's real property tax between buyer and seller by the number of days each owned the property. The settlement statement usually shows the proration. Each party deducts their share, regardless of who wrote the check to the county.

The SALT cap in 2025 and 2026

Property taxes on your home count toward the state and local tax cap in IRC 164(b)(6), together with your sales tax deduction. Under IRC 164(b)(7), the cap is $40,000 for 2025 and $40,400 for 2026, half for married filing separately, and it is reduced by 30 percent of modified adjusted gross income over $500,000 for 2025 and $505,000 for 2026, though never below $10,000. It increases one percent a year through 2029 and falls back to $10,000 in 2030.

For many DFW homeowners, the higher cap means the full property tax bill is deductible again for these years. For high-income households in the phase-down range, the effective cap may still be close to $10,000. My guide to the sales tax deduction explains how sales tax shares the same cap.

Rentals and business property are different

The SALT cap does not apply to property taxes paid or accrued in carrying on a trade or business or an activity for the production of income. The last sentence of 164(b)(6) carves them out. So property taxes on a rental house go on Schedule E, and property taxes on business real estate go on Schedule C, Schedule F, or the business's own return. They reduce income directly, with no cap and no need to itemize.

That makes allocation important. A home office, a duplex where you live in one side, or ranch land with a house on it all require dividing the property tax between personal and business use. Put the personal share on Schedule A and the business share where it belongs. Overstating the business share to avoid the cap is a common adjustment in exams.

Texas business personal property taxes on equipment and inventory are deductible business expenses too. Owners of ranch land should also read my guide on agricultural valuation and the IRS hobby loss rules, because a low ag-valued property tax bill does not settle whether the operation is a business for federal purposes.

Homestead exemptions and protests

The Texas homestead exemption reduces your taxable value, which reduces your bill. It does not change the federal rule. You deduct what you actually paid. The same goes for a successful appraisal protest: a lower value means a lower bill and a lower deduction. If you receive a refund of property taxes deducted in an earlier year, the tax benefit rule in IRC 111 may make part of the refund taxable in the year received.

When property taxes become an IRS problem

The usual issues are small: a deduction claimed for the escrow deposit instead of the amount paid, both buyer and seller claiming the full year, or personal property tax on Schedule E. They show up in exams, not matching notices, because there is no third-party form that reports most of these numbers to the IRS.

The bigger problems come when property taxes go unpaid and the IRS is also owed money. Texas property tax liens, and the lenders who pay them off, can rank ahead of a federal tax lien. My guide on property tax loans and the federal tax lien explains that collision, and the homestead guide covers what the IRS can do to a Texas home.

Property taxes are the one Texas tax nearly every homeowner feels. Deduct them right, keep the county's payment record, and they will not cause federal trouble. If they already have, let's talk: 813-229-7100.