Property Tax Escrow Accounts: How They Work and the New $40,000 SALT Cap (2026 Guide)

If you have a mortgage, your property taxes probably flow through an escrow account — and the federal rules around what you can deduct just changed. The One Big Beautiful Bill Act (OBBBA) raised the SALT deduction cap from $10,000 to $40,000 starting with tax year 2025, but only through 2029, and only for filers under a $500,000 income threshold. This guide walks through how escrow accounts actually work, how the new SALT cap interacts with what you can deduct, and when canceling your escrow account starts to make sense.

What an Escrow Account Actually Is

A property tax escrow account is a holding account managed by your mortgage servicer. Each month, a portion of your mortgage payment is set aside in escrow to cover annual property taxes (and usually homeowners insurance). When the tax bill comes due, the servicer pays it on your behalf using the funds you have built up.

The mechanics are governed federally by the Real Estate Settlement Procedures Act (RESPA), which limits how much "cushion" the servicer can hold (no more than two months of payments) and requires an annual escrow analysis. Your servicer must also send you a Form 1098 each January listing the total mortgage interest paid and, separately, the total property taxes paid out of escrow during the previous year.

Why Lenders Require Escrow

Lenders almost always require escrow when:

• Loan-to-value (LTV) is above 80% — high-LTV loans carry more risk; the lender wants direct control of property tax payment to avoid tax liens that supersede the mortgage
• The loan is FHA, VA, or USDA — federally backed loans require escrow regardless of LTV
• The loan is a high-priced mortgage loan (HPML) under the Truth in Lending Act — Regulation Z requires escrow for the first 5 years
• Borrower credit history is weaker — lender prefers the predictability

Conventional loans with LTV at or below 80% generally allow escrow waivers — sometimes for a small fee. Whether to take the waiver is an individual choice that we will return to.

The 2025-2029 SALT Cap Window: What Changed

The state and local tax (SALT) deduction is the federal income tax deduction that lets you subtract state income taxes (or sales taxes) and local property taxes from your federal taxable income — but only if you itemize.

Before 2018: unlimited

Pre-Tax Cuts and Jobs Act (TCJA), the SALT deduction was unlimited. Homeowners in high-tax states like New York, New Jersey, California, and Massachusetts routinely deducted tens of thousands of dollars in combined state income tax and property tax.

2018-2024: capped at $10,000

TCJA, signed in December 2017, capped the SALT deduction at $10,000 for tax years 2018-2025. For most middle-class homeowners, this hurt — but the simultaneous near-doubling of the standard deduction meant millions stopped itemizing entirely and the impact was muted.

2025-2029: raised to $40,000 (OBBBA)

The One Big Beautiful Bill Act, signed in July 2025, raised the SALT cap to $40,000 for tax years 2025 through 2029. The cap escalates by 1% annually during this window. Two important phase-out rules apply:

• Modified adjusted gross income (MAGI) above $500,000 ($250,000 if married filing separately) — the deduction begins to phase out
• MAGI at or above $600,000 — the cap reverts to $10,000

2030 and beyond: $10,000 (unless extended)

Without congressional action, the SALT cap reverts to $10,000 starting tax year 2030. This is a hard sunset built into the OBBBA legislation.

How Form 1098 Reports What You Paid

Each January, your mortgage servicer sends Form 1098 (Mortgage Interest Statement). The form has specific lines that matter for SALT:

• Box 1 — Mortgage interest paid — used for the mortgage interest deduction (separate from SALT)
• Box 10 — Property taxes paid by lender from escrow — this is the number you use for the SALT property tax line

The IRS rule is unambiguous: you deduct property taxes in the year your servicer actually paid them to the taxing authority, not in the year you contributed the money to escrow. If you funded escrow heavily in December but the servicer did not remit the tax until February, the deduction belongs to the next tax year.

Always cross-check Box 10 against your local tax bill records. Servicer errors do happen — most often, double-counting an installment paid in two different tax years, or missing a supplemental tax bill paid outside the regular cycle.

Escrow Cushion, Shortages, and Surpluses

Each year your servicer performs an escrow analysis — a recalculation of how much should be flowing into escrow based on the next year's expected tax and insurance bills. Three outcomes are possible:

Shortage

If your taxes or insurance went up and the escrow balance is now insufficient, you face a shortage. Servicers either spread the shortage over 12 months (raising your monthly payment), let you pay it as a lump sum, or both. Property tax reassessments are the most common trigger.

Surplus

If your escrow balance is more than $50 over the federally allowed cushion, the servicer must refund the excess within 30 days of the analysis. RESPA enforces this strictly.

Cushion

Federal law allows up to two months of escrow payments as a cushion to absorb timing mismatches. State law sometimes imposes lower limits (e.g., New Hampshire and Vermont have stricter caps).

When Canceling Escrow Makes Sense

Once you have built more than 20% equity and the loan permits, you can usually request to cancel escrow and pay property taxes yourself. The case for canceling:

• You earn interest on the cash — money in escrow does not earn interest in most states. Money in your own high-yield savings account does. On a $6,000 annual property tax bill, that is real money over 10 years
• You catch errors faster — when you pay the bill yourself, you see the assessment, the rate, and the timing directly. Easier to catch overassessment
• You retain control over timing — you can prepay before year-end if it benefits your itemized deduction strategy (subject to the SALT cap and IRS prepayment rules)

The case against canceling:

• Discipline matters — paying $6,000 in one or two installments requires saving for it. Many homeowners prefer the forced budgeting of escrow
• Late payment risk — miss a property tax payment and you face penalties, interest, and ultimately tax lien risk. The escrow account is a service that prevents this
• Lender fee — some lenders charge a one-time fee (often 0.25% of the loan balance) to cancel escrow on a conventional loan. Check first

Strategy: Bunching SALT Deductions Within the OBBBA Window

With the $40,000 SALT cap available only through 2029, taxpayers near the cap have a planning opportunity called SALT bunching:

1. If your annual property tax + state income tax is just under $40,000, you may want to prepay next year's first installment in December of the current year — pulling the deduction into the higher-cap window
2. Conversely, if you are well above $40,000 in any given year, the excess does not carry forward — paying early does not help
3. For 2029 specifically: any prepayment in late 2029 of 2030 taxes will likely fall under the $10,000 cap (because the deduction follows when the servicer pays the tax authority, not when you fund the escrow). Plan accordingly

Important caveat: IRS rules under Notice 2018-54 limit certain prepayments. State and local income taxes generally cannot be deducted in the year you prepay them if they are for a future tax year. Property tax prepayments are deductible only if the tax has been assessed (not just estimated) before year-end. Always consult a tax professional before bunching.

The Hidden Risk: Standard Deduction May Eclipse Itemizing

The TCJA standard deduction for 2026 is approximately $15,000 (single) and $30,000 (married filing jointly), with annual inflation adjustments. To benefit from itemizing — and therefore from the SALT deduction at all — your total itemized deductions (SALT + mortgage interest + charitable contributions + medical above the floor) must exceed the standard deduction.

For many middle-class households with mid-range mortgages and modest property taxes, the standard deduction still wins. The new $40K SALT cap matters most to households in high-tax states with substantial property tax bills, large state income tax burdens, or significant mortgage interest.

What Happens After 2029

The OBBBA SALT cap of $40,000 expires December 31, 2029. Without legislation extending or modifying it, the cap returns to $10,000 starting tax year 2030. The political debate around this sunset will likely intensify in 2028-2029, but no homeowner should plan around an extension that has not yet been enacted.

For long-term planning:

• If you can lock in larger deductions during 2025-2029 — through accelerated payment, mortgage refinance with cash-out for tax-deductible purposes, or charitable bunching — that window has real value
• If your high-tax property is in a state with rising assessments — appeal aggressively now (see our appeal guide); a successful appeal benefits you for the full window plus beyond
• If you are considering relocation between high-tax and low-tax states — model the after-tax cost of housing under both regimes, including the post-2029 reversion

Five Common Escrow Mistakes

1. Not reviewing the annual escrow analysis. Servicer math errors are common, especially after a property tax reassessment or insurance increase. Read the analysis line by line.
2. Confusing what you funded with what was paid. Box 10 of Form 1098 reflects what the servicer actually paid out of escrow. Money sitting in the escrow account at year-end is not deductible.
3. Letting a property tax appeal lapse because escrow handles it. The escrow account is just a payment mechanism. The underlying assessment is still your responsibility to challenge if it is wrong.
4. Failing to update escrow after a successful appeal. If you win a reduction, notify your servicer in writing so the escrow analysis adjusts. Otherwise you continue overfunding for months.
5. Canceling escrow without a discipline plan. Without escrow, the responsibility shifts to you. Set up automatic transfers to a high-yield savings account dedicated to property taxes.