The other day, someone asked me about prepaying next year’s rent on his business. That sounded like a pretty good idea to him because he said he could really use the tax deduction this year. Wouldn’t it be terrific if this concept could really work?
Basically, cash-basis taxpayers do get to deduct their payments in the year that the payments are made—unless the payments are made too early. Alas, this gentleman was only permitted to deduct the January payment early, with the rest being deductible in 2013.
The benefit of making key payments at the end of the year
You’ll find all kinds of articles telling you to maximize your deductions by paying key expenses for 2013 in December 2012. If you make the January payment right at the end of December, so check is actually posted in December, you’ll get the biggest benefit. All the interest for the month of December will have accrued, and you’ll get the deduction for the interest you have paid (not for the payment itself).
Suppose you make your payments early—doubling up the December payment at the beginning of the month, for example. In this case, you’ll get no extra benefit—the regular December payment is already applied against all the interest that had accrued over November.
The benefit of making extra or increased mortgage payments
You will get a big benefit to making extra mortgage payments, though. Add an additional 5 percent or more to your monthly mortgage payment and that extra amount will be applied to principal. This will reduce your overall loan balance and the number of months it will take to pay off the loan.
Try out the numbers with a loan amortization calculator. Enter your present loan balance, your interest rate, and the amount of your payment. The calculator will then show you how long it will take to pay off your loan. Now, increase your loan payment to something you could still afford to pay, such as an extra $50 or $100.
For instance, a $150,000 loan at 5 percent interest with a payment of $805.23 will take 360 months to pay off, including $139,882.80 in interest. Change the payment to $855.23 and ta-dah, you end with 45 fewer payments and save nearly $20,000 interest expenses. Add on an extra $100 per month and you would save 78 payments (more than six years) and over $35,000 in interest.
True, your mortgage interest deduction will get smaller and smaller—but think of all the money you’ll get to get to enjoy once the mortgage payments stop!
Eva Rosenberg, EA is the publisher of TaxMama.com , where your tax questions are answered. Eva is the author of several books and ebooks, including the new edition of Small Business Taxes Made Easy. Eva teaches a tax pro course at IRSExams.com and tax courses you might enjoy at http://www.cpelink.com/teamtaxmama.