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IRS warns property tax prepayments must be properly assessed

Daniel Hood
12.28.2017 | Accounting Today

The Internal Revenue Service offered a very timely warning to tax professionals and taxpayers who are scrambling to prepay property taxes in 2017: To be deductible, the taxes must not only have been paid by the taxpayer, they must also have been properly assessed by the local jurisdiction.

Despite that warning, however, taxpayers shouldn’t ignore the possibility of prepaying, according to Wayne Berkowitz, partner-in-charge of the state and local tax practice at Top 40 Firm Berdon LLP. “We’ve had tons and tons of interest from clients. What a lot of people are missing, and it’s kind of borne out in the IRS announcement, is that your property taxes consist of many components – school taxes, county taxes, town taxes, and so on – and the largest component is the school tax,” he explained. “In Nassau County, for instance, school taxes for first half of 2018 have been assessed and warranted – and for many people, that’s 70 percent of your property tax.”

Noting that it has received a number of questions for tax professionals, the IRS issued IR-2017-2010 late on Wednesday to clarify some of the issues surrounding the state and local property tax deduction.

The recently passed Tax Cuts and Jobs Act will reduce the amount of state and local taxes that can be deducted to just $10,000, and specifically disallows prepaying state and local income taxes. It leaves open the possibility of prepaying property taxes, which has led many to scramble to make payments in 2017 in hopes of claiming them on their next tax return.

The IRS Advisory pointed out an important hurdle for them, however: “A prepayment of anticipated real property taxes that have not been assessed prior to 2018 are not deductible in 2017,” it warned. “State or local law determines whether and when a property tax is assessed, which is generally when the taxpayer becomes liable for the property tax imposed.”

It offered two examples to clarify what would and would not be deductible:

  • Example 1: Assume County A assesses property tax on July 1, 2017, for the period July 1, 2017–June 30, 2018. On July 31, 2017, County A sends notices to residents notifying them of the assessment and billing the property tax in two installments with the first installment due Sept. 30, 2017, and the second installment due Jan. 31, 2018. Assuming the taxpayer has paid the first installment in 2017, they may choose to pay the second installment on Dec. 31, 2017, and may claim a deduction for this prepayment on their 2017 return.
  • Example 2: County B also assesses and bills its residents for property taxes on July 1, 2017, for the period July 1, 2017–June 30, 2018. County B intends to make the usual assessment in July 2018 for the period from July 1, 2018–June 30, 2019. However, because county residents wish to prepay their 2018-2019 property taxes in 2017, County B has revised its computer systems to accept prepayment of property taxes for the 2018-2019 property tax year. Taxpayers who prepay their 2018-2019 property taxes in 2017 will not be allowed to deduct the prepayment on their federal tax returns because the county will not assess the property tax for the 2018-2019 tax year until July 1, 2018.

Many jurisdictions will have a mix of assessed and unassessed taxes. In New York City, for instance, where the property tax fiscal year runs from July 1 through June 30, people can pay their property tax bills for the third and fourth quarters before the due dates, according to the city’s Department of Finance. The department is instructing people to consult their tax advisers before making such payments.

The city’s tax roll for the 2018-2019 tax year won’t be completed until May — so property tax bills for July 2018 through December 2018 won’t be determined until June, according to the department.

Beware the AMT

Berdon’s Berkowitz did point out that taxpayers should make sure they won’t be subject to the Alternative Minimum Tax before they prepay, as that would make the deduction moot – and the high-tax states like California, Connecticut, Massachusetts, New Jersey and New York where prepayment is of most interest are also the ones were people are more likely to get hit by the AMT.

Even with that said, though, Berkowitz puts a “positive spin” on the IRS Advisory: “We’re hoping that it might make people come to the realization” that some of their 2018 taxes may already have been assessed, he said. “I’m looking at it as some comfort. It’s clear that if you pay the assessed school tax portion now, it’s going to be deductible, if you’re not in the AMT.”

Michael Egan, a tax manager at Berdon, said that many local jurisdictions are trying to help, but have their own constraints. “The states and counties are scrambling to accommodate taxpayers, but they may not be able to,” he said. “For instance, some counties in Maryland were scrambling, but they gave up because they just didn’t have the time” to make assessments and accept all the prepayments that taxpayers wanted to make.

“I’m not sure how successful they’ve been, but they’re open for business and accepting payments,” Berkowitz added. “But have they properly issued their warrants? There are going to be problems with the application of payments and tracking payments, because they’re just not equipped to handle all this.”

His final advice to taxpayers? “Don’t panic. Don’t follow the herd mentality – think about what it means for you and whether it’s worth it to you,” he said.

Bloomberg News’ John Voskuhl contributed to this