Property Tax Deduction Strategies
Homeowners can deduct real estate taxes on Schedule A
It can sometimes seem like one tax authority or another always has its hand out for your money. If the federal government doesn't get you, your state will ask for a share. Even local governments get into the act, assessing taxes on property you own.
But some taxes come with built-in checks and balances so that what one government takes away, another gives back. The Internal Revenue Service lets you deduct the cost of those property taxes you must pay.
Of course, rules abound.
Here's what the IRS has to say about it in Publication 530: "Most state and local governments charge an annual tax on the value of real property. This is called a real estate tax. You can deduct the tax if it is assessed uniformly at a like rate on all real property throughout the community. The proceeds must be for general community or governmental purposes and not be a payment for a special privilege granted or service rendered to you."
You must be the property owner to claim the deduction. If you pay your mother's property taxes for her because she's getting up in years and is having a hard time making ends meet, this is not deductible because the tax isn't levied against you personally.
Property taxes are reported on Schedule A. This means you must itemize to claim the deduction, and the total of all your itemized deductions should be more than the standard deduction you're entitled to for your filing status.
Otherwise, claiming the deduction is probably not worth your while—your overall tax bill could end up being more. You might want to prepare your tax return both ways to be sure.
Property Taxes Paid Through Escrow Accounts
You can deduct property tax payments you make directly to the tax authority, as well as payments made through an escrow account at settlement or closing.
Some taxpayers continue to pay their property taxes through payments into an escrow account that are included in their mortgage payments. The mortgage lender then remits payment to the tax authority on behalf of the homeowner. In this case, you can only deduct the amount the lender actually pays out for property taxes—the actual tax amount—even if you pay more into escrow over the course of the year.
Allocating Property Taxes When Real Estate Is Sold
Property taxes are often split between the seller and the buyer when real estate is bought and sold. The IRS provides specific guidance as to how to determine the amount of property taxes allocated to each: "Real estate taxes are generally divided so that you and the seller each pay taxes for the part of the property tax year you owned the home. Your share of these taxes is fully deductible if you itemize your deductions."
Certain Charges on Property Tax Bills
Sometimes a property tax bill includes charges or fees for services, or assessments for local benefits. These are not deductible as property taxes. Transfer or stamp taxes or assessments made by a homeowner's association are also not deductible.
Service charges include things like water service, trash service, and services performed by the government that are related specifically to your property, not all local properties as a whole.
According to the IRS, "An itemized charge for services assessed against specific property or certain people is not a tax, even if the charge is paid to the taxing authority."
Assessments for local benefits mean charges on your property tax bill that are for "local benefits that tend to increase the value of your property. Local benefits include the construction of streets, sidewalks, or water and sewer systems." Because these expenses are related to increasing the value of your property, they're not deductible as property taxes.
Recordkeeping for the Property Tax Deduction
Retain copies of your property tax statements and your canceled checks to show proof of payment. You should also keep any escrow documents from when the property was purchased or sold because these may show additional payments of property tax that you can likewise deduct.
Impact on the Alternative Minimum Tax
The property tax deduction is an adjustment item when you're calculating the alternative minimum tax, sometimes referred to as the AMT. This means that although the property tax deduction reduces taxable income when you're calculating regular federal income tax, it not deductible when calculating the AMT. Taxpayers who are subject to the AMT will typically find that their property tax deduction results in little or no reduction in their overall federal tax liability.
Year-End Tax Planning Using Property Taxes
Taxpayers can pre-pay the next installment of their property tax before the end of the year to help boost their itemized deductions in the immediate year. In most cases, these taxes are deductible in the year you pay them, not the year they technically come due. For example, you might pay the spring property tax installment in advance in December before the current year ends. This would increase the amount of property tax you paid during the year and increase the amount of your deduction.