Real Estate Taxes for Individuals- The Who, What & When of Deductibility
A taxpayer may take a deduction for taxes paid on all property owned by the taxpayer, including a main home, vacation home, land and even a houseboat. Unlike the mortgage interest deduction, a taxpayer is not limited by the number of qualifying properties.
A cash basis taxpayer may deduct real estate taxes that are prepaid unless he or she lives in an area where the taxing authority would consider the payment a deposit. However, what happens to taxes paid on a monthly basis as part of a mortgage payment and put in escrow to be paid by the lender as the taxes come due? In this case, a deduction is allowed only when the lender physically disburses the taxes out of escrow. Fortunately, we are not left to wonder when this happens as the lender will reflect the proper amount paid on Form 1098 provided on an annual basis to the taxpayer.
A service charge levied by a government body for the general public welfare (such as trash collection or police and fire protection) is deductible if the charge is based on the assessed property value and applied uniformly against all properties in the jurisdiction. Therefore, special assessments benefiting a specific property are not deductible. Special assessments that are applied uniformly might be deductible as long as they do not increase the value of the property. Also, the funds collected must not be earmarked but comingled with general revenue funds. Special assessments not allowed as a deduction should be added to the basis of a property.
On the purchase or sale of real property, the taxes are split between the buyer and seller according to the number of days each owns the property. Regardless of how, or even if, this allocation is reflected on the closing statement, the buyer and seller may only deduct his or her respective shares. So, if the property is sold with no mention of real estate taxes, it is presumed to be reflected in the purchase price and an allocation is made based on days owned. The seller can deduct the amounts paid directly minus any amount allocated to the buyer, even if not reimbursed; likewise, for the buyer.
Real estate taxes can only be deducted by the owner of the property. Generally, this means the person with legal title to the property, but it actually extends to an equitable owner. Looking to the economic substance rather than the legal form of home ownership, courts have ruled that a taxpayer might be considered an equitable owner and allowed a deduction in situations where he or she occupied and maintained the home as well as paid the mortgage and taxes. As an equitable owner, he or she enjoyed the benefit and bore the burden of the home. Accordingly, the equitable owner was allowed the deduction.
For taxes paid on unimproved and unproductive land, an election can be made on an annual basis to include the cost in basis as opposed to taking a current tax deduction. This can be useful in years where the taxpayer does not benefit from the expense and the election is available for the interest paid on the property as well.
While it is always a good idea to keep records of what was paid as well as reported on Form 1098, a taxpayer can typically go to the tax assessor website for the city or county tax to determine the amount paid. Look for a “property search” or “property tax records” link.
Taxpayers should be aware that real estate taxes are generally not deductible for alternative minimum tax (AMT) purposes. A taxpayer might unknowingly accelerate a payment (i.e. half in January, half in July, half in December) and find himself or herself subject to AMT. Likewise, a taxpayer trying to catch up after being behind on taxes (such as happens when the property is sold and back taxes are paid off) might also be subject to AMT.
And this leads us to the new tax proposals by the Trump Administration, in which they are seeking to repeal the deduction for real estate taxes and most “tax breaks,” but have noted certain exceptions – such as the mortgage interest deduction would be preserved. The alternative minimum tax could also be repealed. Stay tuned for what actually becomes law and what winds up on the cutting room floor.
Ask Our Experts
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Rebecca Machinga, CPA, CGMA 609-520-1188 [email protected]
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To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
