Do You Have to Claim Your Escrow Surplus Check on Your Taxes?

When you receive an escrow surplus check from your mortgage lender, you do not need to report it on your tax return. That check isn't income to you. It's simply a refund of money that you provided to the lender to use to pay bills on your behalf. A look at how mortgage escrow works makes clear why a surplus check is not taxable income.

Escrow

If you're like most other homeowners with a mortgage, your monthly mortgage payment includes more than just principal -- the borrowed money you're paying back -- and interest, or what the bank is charging you for using its money. Your payment also includes part of your annual property tax bill and a portion of your annual premium for homeowners insurance. Your lender collects this money from you in 12 equal installments over the course of a year, puts it in a special account -- an escrow account -- and uses it to pay your taxes and insurance premiums.

Cushions

Federal law limits how much your lender can require you to contribute to your escrow account. By the time a tax or insurance bill comes due, the account must have enough money in it to pay the bill, so your lender can set your escrow payments so the account is funded to that level. But the lender can also require you to keep an additional amount in the account -- a "cushion" to absorb unexpected cost increases. Under the Real Estate Settlement Procedures Act, the lender can require a cushion equal to one-sixth of the total amount paid out of escrow each year. Because each monthly payment accounts for one-twelfth of your combined annual tax and insurance bill, the maximum cushion is essentially two months' worth of escrow payments.

Surpluses and Refunds

If the amount of excess money in your escrow account grows to be larger than the allowable cushion, you've got an "escrow surplus." The lender can take a surplus of up to $50 and apply that money to your future escrow payments. But you have the right to receive a refund check for any surplus over $50. If you don't want a refund, your lender may give you the option of using a larger surplus to reduce future payments or to pay down your loan principal. If you sell your home and have unused money left in your escrow account, the full amount of that surplus must be refunded to you.

Property Taxes

Some homeowners may wonder whether escrow refunds affect their property tax deductions. After all, money is set aside in escrow to pay property taxes, and those taxes are deductible on your income taxes. However, you can only deduct the taxes that are paid out of the escrow account -- the amount of money the bank actually pays to the taxing authority. You don't deduct the money you put into escrow, so the unused portion that gets returned as a refund doesn't have any effect on your property tax deduction.

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