Paying Off Your Rental Mortgage vs. Keeping the Tax Break

By Bobbye Joe McMillan

Bobbye Joe McMillan is the driving force behind Cornerstone Property Management, bringing over 30 years of expertise in real estate to help clients achieve their property goals.

A mortgage on a rental property comes with a tax deduction, and for some owners, that deduction is the main reason the loan never gets paid off.

It can be a good reason to keep a loan, but only if the deduction is doing as much as you think. That depends on your tax bracket, how your rental losses are treated, and what that money could be doing instead.

As a property manager, I see the full income and expense picture on the rentals I manage. These are the four points I’d look at first.

1. The deduction is real. The IRS says you can deduct mortgage interest you pay on your rental property. You report it on Schedule E, where the instructions tell you to enter on line 12 the amount of interest you paid for 2025 to banks or other financial institutions.

Only the interest counts. The principal part of each payment comes out of your account every month, but it isn’t a deductible expense.

2. It saves only your tax rate. A deduction lowers the income you pay tax on. Each dollar of interest saves you your tax rate on that dollar, not the whole dollar.

For example, one of the 2026 federal brackets is 24% for incomes over $105,700 ($211,400 for married couples filing jointly). If you’re in that bracket and pay $10,000 a year in mortgage interest, the deduction saves you about $2,400 in federal tax. The other $7,600 is still a cost you carry.

3. Passive loss rules can limit it. Rental losses follow their own rules. The IRS says that, generally, rental activities are passive activities even if you materially participated in them.

There is an exception. If you or your spouse actively participated in a passive rental real estate activity, you may be able to deduct up to $25,000 of loss from the activity from your nonpassive income.

That allowance is reduced by 50% of the amount of your modified adjusted gross income that is more than $100,000. At $150,000 or more, you generally can’t use the special allowance.

So if your rental already shows a loss on paper, extra interest may not lower this year’s tax.

4. Cash flow should make the call. Once you understand the tax side, the decision comes down to cash.

Keeping the mortgage leaves more money on hand for vacancies, repairs, and surprises. Paying it off raises your monthly cash flow, but that money is then tied up in the property.

If you ever want that cash back, you’ll need a new loan, and how you use it matters. The IRS notes that when you refinance a rental property for more than the previous outstanding balance, the portion of the interest allocable to loan proceeds not related to rental use generally can’t be deducted as a rental expense.

Bring real figures to your CPA. The right choice depends on your rate, your tax bracket, your reserves, and your plans for the property. Your CPA can help you weigh those, and the conversation goes faster with accurate rental numbers in hand.

I’m not a CPA, but I can show you exactly what your rental earns and what it costs to run. Call or text me at 210-440-1223, email me at bmcmillan@cornerstonepmtx.com, or visit blog.cornerstonepmtx.com. I’m glad to help you get the numbers ready.