Taxes Incurred by Paying Off Mortgages with Lottery Winnings

Paying off your mortgage will save you money but increase your taxes.


Winning the lottery is a windfall that can potentially be life-changing based on the jackpot. Coming into a large sum of money gives you the opportunity to pay down your debts and make a new life for yourself. On the other hand, it also creates a significant income opportunity for the government, which will be taxing you along the way.

Tax on Lottery Winnings

The first tax that you pay after winning the lottery has to do with your windfall. The federal government and certain states -- not including California -- tax lottery winnings as ordinary income. The tax rate you pay varies based on your current income and how much you won. The money you use to pay off your mortgage will be with after-tax dollars. For example, consider a married couple with a pre-lottery winnings taxable income of $50,000 in the 2012 tax year. Their first $20,700 of lottery winnings would be taxed at 15 percent, with the rest being taxed at rates varying from 25 to 35 percent on any winnings over $338,350.

Mortgage Interest Deduction

When you pay off your mortgage, you will lose the ability to write off the mortgage interest that you pay. That tax deduction can be a valuable write-off that reduces your tax liability. Then again, the interest that you pay is more than the value of the tax savings that it gives you.

Remaining Taxes and Charges

Paying off your mortgage won't free you from any other taxes or charges that you have to pay on your property, such as property taxes and homeowners insurance. If you pay these expenses through your mortgage's escrow account, you will have to start paying these bills directly to your county assessor and to your insurance carrier once the mortgage is paid off.

Payment Strategy

If your lottery winnings are large enough to pay off your mortgage and all of your other debts, paying everything off can be a financially savvy move. If your lottery winnings will not cover all of your debts, pay off the debts that have the highest interest rates first. From there, pay off your second mortgage and then your first mortgage. This strategy will ensure that you pay the lowest amount of interest possible while retaining the biggest tax deductions. Consult with a tax professional and financial adviser for the best strategy for your situation.

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