Real Estate Taxes Are Subject to a $10,000 Limit. Or Are They?
By Christian J. Hofflinger, CPA
The 2017 Tax Cuts and Jobs Act brought with it numerous changes affecting businesses and individuals. One of the most recognized and controversial changes for individuals was the $10,000 cap placed on itemized deductions for state and local taxes. This article will explore how this cap applies to you.
Before the change, individual taxpayers who itemized were allowed a deduction for property taxes paid to state and local taxing authorities, as well as a deduction for either state income tax or general sales tax. Taxpayers who currently itemize are still allowed those deductions but with one major caveat: They are now limited to $10,000 ($5,000 for married filing separately). This sweeping change has created much controversy, especially among residents of states with historically high property taxes who are now limited in the amount of deduction available to them.
However, it’s important to note that there are some situations to which the property tax cap doesn’t apply. One example is vacant land held for investment. Individuals who own vacant land generally do not receive any income from the land and also are not entitled to any business deductions related to it. The real estate taxes paid on vacant land, before the passing of the Tax Cuts and Jobs Act, were an itemized deduction on Schedule A. Therefore, it would appear at first that with the new rules in place these taxes would be subject to the $10,000 cap. Upon further review however, this may not be the case. Section 164(b)(6) of the Internal Revenue Code provides exceptions for taxes that are paid or accrued in carrying on a trade or business and activities described in Section 212.
One of the activities described in Section 212 is the “management, conservation, or maintenance of property held for the production of income.” This section further states that “income” includes prior, current and subsequent years. It also states that “income” includes not only recurring income but also gains from the disposition of the property. Most real estate investors purchase property with the intention of selling it in the future at a gain. So, it appears that property taxes paid on real estate investment property would not be subject to the $10,000 cap.
Taxes paid on investment property should be reported as “Other Taxes” on Line 6 of Schedule A, Form 1040. One note of caution, however, is that taxes are not a deduction for Alternative Minimum Tax purposes. Depending on the situation, including these additional tax deductions may not result in any less Federal Income Tax being owed. In those situations consideration should be given to making an election under Section 266 to capitalize the taxes paid to the basis of the property, thus reducing the amount of capital gain once the property is sold.
Other property taxes not subject to the $10,000 cap are those paid for rental properties and those paid in the ordinary course of a trade or business, such as an operating company. Unfortunately property taxes paid on personal use property, second homes and vacation homes, while still deductible as itemized deductions, are subject to the $10,000 limitation.
The new laws are complex. So, if you’re wondering how the $10,000 tax cap does or does not apply to you, please do not hesitate to contact us at Sol Schwartz and Associates.
Christian J. Hofflinger is a Tax Manager at Sol Schwartz & Associates in San Antonio, which is celebrating its 40th anniversary this year. He may be reached at 210.384.8000, or email@example.com.