Mortgage Interest and Property Tax Deductions in California: What’s Still Deductible?

For homeowners in California, particularly in high-cost regions like the Bay Area, understanding mortgage interest and property tax deductions can lead to significant tax savings. These federal tax deductions, shaped by the Tax Cuts and Jobs Act (TCJA) of 2017, allow eligible homeowners to reduce their taxable income, offsetting the high cost of homeownership. However, recent changes to tax laws have altered what’s deductible, especially in a state with sky-high property values and taxes. This article explains what remains deductible for California homeowners, with a focus on federal and state tax rules and Bay Area-specific considerations.

Overview of Mortgage Interest and Property Tax Deductions

The IRS allows homeowners to deduct certain mortgage interest and property taxes on their federal tax returns, subject to specific limits. In California, where median home prices in areas like San Francisco ($1.4 million) and Palo Alto ($2 million+) result in substantial mortgages and property tax bills, these deductions are particularly valuable. However, the TCJA introduced caps and restrictions that impact what you can deduct, and California’s state tax code does not always align with federal rules.

Mortgage Interest Deduction

The mortgage interest deduction allows homeowners to deduct interest paid on mortgage loans used to buy, build, or improve their primary or second home. Here’s what’s still deductible:

Federal Rules

  • Eligible Loans: You can deduct interest on mortgage debt up to $750,000 for married couples filing jointly or $375,000 for single filers (reduced from $1 million/$500,000 pre-TCJA). This applies to loans taken after December 15, 2017.
    • For loans originated before December 15, 2017, the higher $1 million/$500,000 limit still applies (grandfathered loans).
  • Qualifying Properties: The deduction applies to your primary residence and one second home (e.g., a vacation home), as long as the loan is secured by the property.
  • Eligible Interest: Includes interest on fixed-rate or adjustable-rate mortgages, as well as home equity loans or lines of credit (HELOCs) used for home improvements (not for other purposes, like paying off credit card debt).
  • Itemized Deduction: You must itemize deductions on IRS Schedule A to claim this, forgoing the standard deduction ($13,850 for singles, $27,700 for married filing jointly in 2023, adjusted annually).

California Rules

  • California generally conforms to federal rules for mortgage interest deductions, allowing you to deduct interest on up to $1 million in mortgage debt for state taxes, even for loans after 2017. This is a key advantage for Bay Area homeowners with large mortgages.
  • Limitation: You must itemize on your California tax return (Form 540, Schedule CA) to claim the deduction, and high earners may face phase-outs due to California’s progressive tax rates (up to 13.3%).

Example

  • Scenario: You buy a $1.5 million home in San Jose with a $1.2 million mortgage (30-year, 6% interest). In the first year, you pay ~$72,000 in interest.
  • Federal Deduction: You can deduct interest on up to $750,000 of the loan (~$45,000 in interest), assuming you itemize.
  • California Deduction: You can deduct interest on up to $1 million (~$60,000), potentially saving more on state taxes.
  • Savings: At a 24% federal tax rate and 9.3% California rate, this could reduce your federal taxes by ~$10,800 and state taxes by ~$5,580.

Bay Area Consideration

In the Bay Area, where homes often exceed $1 million, the $750,000 federal cap limits deductions for many buyers. However, California’s $1 million limit offers additional relief for state taxes, making it critical to consult a tax professional to maximize savings.

Property Tax Deduction

The property tax deduction allows homeowners to deduct property taxes paid to local governments, but the TCJA imposed significant restrictions.

Federal Rules

  • SALT Cap: The TCJA caps the total deduction for state and local taxes (SALT), including property taxes, at $10,000 per year ($5,000 for single filers) for all itemized deductions combined (e.g., property taxes, state income taxes, sales taxes).
  • Eligible Taxes: You can deduct property taxes assessed by the county based on the property’s assessed value under Proposition 13 (1% of assessed value plus local assessments, typically 1.1–1.2%).
  • Itemized Deduction: Like the mortgage interest deduction, you must itemize on Schedule A, forgoing the standard deduction.

California Rules

  • No SALT Cap for State Taxes: California does not impose a cap on property tax deductions for state income tax purposes, allowing you to deduct the full amount paid, subject to itemization.
  • Proposition 13 Impact: Property taxes are based on the purchase price at acquisition, with annual increases capped at 2% or inflation (whichever is lower). New buyers face a reassessment, increasing taxes significantly compared to long-term owners.

Example

  • Scenario: You buy a $1.5 million home in Oakland with an assessed value of $1.5 million. Annual property taxes are ~$18,000 (1.2% including local assessments).
  • Federal Deduction: You can deduct up to $10,000 of property taxes (combined with other SALT), saving ~$2,400 at a 24% tax rate.
  • California Deduction: You can deduct the full $18,000, saving ~$1,674 at a 9.3% state tax rate.
  • Challenge: If you also pay high state income taxes (common for Bay Area professionals), the $10,000 federal SALT cap limits your total deduction.

Bay Area Consideration

Bay Area homes often have property tax bills exceeding $10,000 (e.g., $20,000 for a $2 million home), making the federal SALT cap a significant limitation. California’s uncapped deduction provides relief, but high earners (taxed at 12.3–13.3%) may still face substantial tax burdens.

Supplemental Taxes and Deductibility

In California, supplemental taxes are assessed when a property changes ownership or undergoes significant improvements, reflecting the difference between the prior and new assessed values (see Proposition 13). These taxes are deductible under the same rules:

  • Federal: Supplemental taxes count toward the $10,000 SALT cap if you itemize.
  • California: Fully deductible on your state return, with no cap.
  • Example: If you buy a $1.2 million home with a prior assessed value of $400,000, you may receive a supplemental tax bill of ~$4,800 for the partial year. This is deductible, but federally, it’s subject to the $10,000 SALT cap.

Key Considerations for California Buyers

  1. High-Cost Market:
    • In the Bay Area, median home prices ($1–2 million) often result in mortgages exceeding the $750,000 federal cap and property taxes exceeding the $10,000 SALT cap, limiting federal deductions.
    • California’s higher $1 million mortgage interest cap and uncapped property tax deduction offer additional state tax savings.
  2. Itemizing vs. Standard Deduction:
    • To claim these deductions, you must itemize, which only makes sense if your total deductions (mortgage interest, property taxes, charitable contributions, etc.) exceed the standard deduction ($13,850 single, $27,700 married filing jointly in 2023).
    • In the Bay Area, high mortgage interest and property taxes often make itemizing worthwhile, but consult a tax professional to confirm.
  3. Investment Properties:
    • For rental properties, mortgage interest and property taxes are deductible as business expenses on IRS Schedule E, not subject to the $750,000 or $10,000 caps, but subject to passive loss rules.
    • California conforms to federal rules for rental deductions, with no SALT cap for state taxes.
  4. Tax Planning:
    • Use a 1031 exchange to defer capital gains taxes when selling investment properties, preserving funds for future purchases.
    • Explore homeowner’s exemptions (up to $7,000 reduction in assessed value) for primary residences to lower property taxes.

Practical Steps for Buyers

  1. Estimate Deductions:
    • Calculate potential mortgage interest based on your loan amount and interest rate (e.g., 6% on a $1 million loan = ~$60,000/year interest).
    • Estimate property taxes using 1.1–1.2% of the purchase price, plus potential supplemental taxes for the first year.
  2. Budget for Taxes:
    • Include property taxes and supplemental taxes in your monthly budget, as they may not be fully covered by deductions.
    • If using an escrow account, ensure it accounts for regular taxes; supplemental taxes are typically billed separately.
  3. Review Loan and Tax Details:
    • Work with your lender to understand your mortgage terms and interest payments.
    • Request the seller’s prior assessed value to estimate supplemental taxes.
  4. Maximize Deductions:
    • Keep records of mortgage interest (reported on Form 1098) and property tax payments (available from the county assessor).
    • Itemize deductions if they exceed the standard deduction, especially in high-cost areas like the Bay Area.

Work with Professionals

Navigating California’s tax deductions requires expertise:

  • Real Estate Agent: A Bay Area agent can estimate taxes, explain Proposition 13 impacts, and connect you with tax professionals.
  • Tax Professional: A CPA can optimize deductions, confirm itemization benefits, and advise on rental properties or 1031 exchanges.
  • Mortgage Broker: Helps secure loans within deductible limits and explains interest projections.
  • County Assessor: Provides tax rates, supplemental tax estimates, and exemption applications (e.g., homeowner’s exemption).

Final Thoughts

Mortgage interest and property tax deductions remain valuable for California homeowners, especially in the Bay Area’s high-cost market, but federal limits ($750,000 for mortgage interest, $10,000 for SALT) restrict their full benefit. California’s more generous state tax rules offer additional savings, making it critical to plan strategically. By estimating deductions, budgeting for taxes, and working with professionals, buyers can maximize tax benefits and make informed homeownership decisions in one of the nation’s most expensive markets.

Disclaimer: This article provides general information about mortgage interest and property tax deductions in California and is not a substitute for professional tax advice. Tax laws are complex and subject to change. Consult a licensed tax professional or financial advisor for personalized guidance on your specific situation.