Property Tax Deduction Strategies Under the New Tax Law
Homeowners can still deduct real estate taxes on Schedule A
It can sometimes seem like one taxing 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 and county 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 property taxes you must pay to local taxing authorities.
Of course, rules abound and those rules changed somewhat with the passage of the Tax Cuts and Jobs Act, effective January 2018. The property tax deduction isn't quite the same as it was in previous years.
Here's what the Internal Revenue Service 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.
You Have to Itemize
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 claim 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 because the new tax legislation doubled standard deductions. They're set at these figures for the 2018 tax year:
- $12,000 for single taxpayers and married taxpayers filing separate returns
- $24,000 for married taxpayers filing jointly and qualifying widow(ers)
- $18,000 for those who qualify to file as head of household.
The total of all your itemized deductions must exceed the applicable amount to make itemizing—and claiming the property tax deduction—worth your while. Otherwise, you could end up paying taxes on more income than you have to.
The Tax Cuts and Jobs Act Limit
The TCJA also limits the amount of property taxes you can claim beginning in 2018, placing a $10,000 cap on state, local, and property taxes collectively. This ceiling also applies to income taxes you pay at the state and possibly local level as well as property taxes. They all fall under the same umbrella.
If you spend $6,000 on state income taxes and $6,000 on property taxes, you no longer get a $12,000 deduction thanks to the TCJA. You can claim $10,000 of these expenses, but the new law effectively forces you to leave $2,000 on the table, unclaimed.
The limit is only $5,000 if you're married but file a separate return, and property taxes for personal foreign real property have been eliminated entirely.
Property Taxes Paid Through Escrow Accounts
Within this new limit, you can still deduct property tax payments that you make directly to the taxing authority as well as payments made into an escrow account that are included in your mortgage payments. In this case, your mortgage lender would then remit payment to the taxing authority on your behalf.
You can only deduct the amount your 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 deductible if you itemize your deductions."
Other 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 other 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," according to the IRS. "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 or bank statements to show proof of payment. You should also keep any escrow documents from the time 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 can reduce your taxable income when you're calculating your regular federal income tax, it is 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. This was the case before the new tax law took effect and it's still the case in 2018 and going forward under the terms of the TCJA.
Year-End Tax Planning Using Property Taxes Has Changed, Too
Taxpayers used to be able to 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. Unfortunately, that also changed with the TCJA, at least to some extent.
These taxes were previously deductible in the year you paid them, not necessarily the year they technically came due. For example, you might have paid your spring property tax installment in advance in December before the current year ended. This would increase the amount of property tax you paid during the year ending in December and increase the amount of your deduction for that tax year.
Hordes of taxpayers attempted to do this in late 2017 when the tax law change was looming in January 2018. They wanted to claim their property tax deduction without limit for the 2017 tax year. This prompted the IRS to issue a ruling that these taxes would only be deductible if they had already been assessed by the tax authority.
In other words, you can't take an educated guess as to what your property taxes would be and pay them in advance. You must have received a statement from your tax authority stating the exact amount you owe. This is expected to continue to be the case in future years.