Taxes are a fact of life. Sales tax, income tax, property tax…the list seems to never end. Yet that is part of the price we pay as a privilege living where we live. Yes, some taxes are tax “deductible” but that only transfers the tax burden from oneescrow shortages on investment real estate source to yet another. When owning investment real estate, there are definite tax advantages owning rental property, and one of those advantages addresses how to deduct property taxes from taxable income, lessening the income tax burden.

Property taxes are typically paid annually or semi-annually and can be paid in a lump sum when due or paid by the lender through an escrow account established by the borrower. An escrow account collects a monthly installment that will ultimately be used to pay the property tax bill. Some real estate investors enjoy the convenience of having the lender pay the taxes when due from an escrow account and appreciate the cash flow advantages as well. Sometimes though, the escrow account comes up a bit short and there’s not enough money in the account to pay the tax bill. What happens?

It’s called an escrow shortage and lenders anticipate this shortage when establishing the original escrow account. When you buy and finance a rental property, you have the option of setting up an escrow account or paying the taxes when due. If you want escrows, the lender may collect up to two months payments to start the fund. If the property taxes increase from the time the home was purchased to when the tax bill is due, the extra two months in reserve will go toward the shortage.

If there are still not enough funds to cover the property tax bill, the lender will go ahead and pay the tax when due on your behalf then collect from you later either in one lump sum or installments. Is having an escrow account better than not having one? There really is no major advantage of one over the other yet is simply a matter of personal preference.