TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Friday, December 29, 2017

Confusion Reigns As People Race To Prepay (And Deduct) Property Taxes By Year-End

IR-2017-210, Prepaid Real Property Taxes May Be Deductible in 2017 if Assessed and Paid in 2017:

The Internal Revenue Service advised tax professionals and taxpayers today that pre-paying 2018 state and local real property taxes in 2017 may be tax deductible under certain circumstances.

The IRS has received a number of questions from the tax community concerning the deductibility of prepaid real property taxes. In general, whether a taxpayer is allowed a deduction for the prepayment of state or local real property taxes in 2017 depends on whether the taxpayer makes the payment in 2017 and the real property taxes are assessed prior to 2018.  A prepayment of anticipated real property taxes that have not been assessed prior to 2018 are not deductible in 2017.  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.

The following examples illustrate these points.

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 taxpayer has paid the first installment in 2017, the taxpayer may choose to pay the second installment on Dec. 31, 2017, and may claim a deduction for this prepayment on the taxpayer’s 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 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.

Victor Thuronyi, Can You Prepay 2018 Property Tax in 2017?:

It turns out this question get[s] more complex by the day. ...

[T]his is not just about taxpayers rushing to save some tax by year-end maneuvers. Whether it is the taxpayers who make the prepayments or the ones who see others making them and wondering whether they should have done this or why this was not handled in a better way, this issue should help cement in peoples’ minds that the 2017 tax act was not just bad policy (giveaways to the wealthy) but poorly made policy. The two are interconnected, because the secretive and rushed way that the policy was made facilitated making policy that benefited the wealthy campaign donors of Republican politicians, their wealthy friends, and the wealthy Republican politicians themselves.

Wall Street Journal, Looking to Prepay Property Taxes? Check Local Timetables First:

The Internal Revenue Service sparked last-minute confusion over the eligibility of property-tax prepayments, making local governments scramble Thursday to interpret the IRS notice with just days left in the year.

Homeowners in high-tax states rushed this week to prepay their property taxes to deduct them from their 2017 federal taxes before the new tax law takes effect in January. The Republican tax legislation signed by President Donald Trump on Dec. 22 caps the amount of state and local tax deductions to $10,000, which could reduce the tax benefits of homeownership.

The IRS poured cold water on their efforts in an advisory late Wednesday that said only people whose local governments had completed 2018 property assessments could prepay their real-estate taxes and claim the full amount from federal taxes before the cap kicks in.

New York Times, Prepaying Your Property Tax? I.R.S. Cautions It Might Not Pay Off:

The Internal Revenue Service has a message for the homeowners rushing to prepay their property taxes before new rules take effect on New Year’s Day: Not so fast.

The tax bill that President Trump signed into law last week sharply limited the itemized deductions for state and local taxes while raising the standard deduction for individuals and couples. Those rules do not take effect until 2018, however. That has led some homeowners, particularly in high-tax, affluent areas, to try to prepay their 2018 property taxes before the deduction disappears.

In an advisory notice posted to its website on Wednesday, the I.R.S. said that maneuver could work, but only under limited circumstances. To qualify for the deduction, property taxes not only need to be paid in 2017, they must also be assessed in 2017 — meaning that homeowners who prepaid their taxes based on estimated assessments, or who tried to pay several years’ worth of taxes at once, will probably be out of luck.

http://taxprof.typepad.com/taxprof_blog/2017/12/confusion-reigns-as-people-race-to-prepay-and-deduct-property-taxes-by-year-end.html

IRS News, Tax | Permalink

Comments

I think that allowing people to get away with this is clearly contrary to the intent of the legislation.

Posted by: mike livingston | Dec 29, 2017 4:37:59 AM

It seems to me that prepaid taxes should be deductible, even if the state has not formally assessed the tax. Individual taxpayers generally operate on a cash basis--deductions are taken when payments are made. When I received distributions from my retirement accounts throughout 2017, I choose to have state taxes withheld--even though I didn't need to have them withheld. Those state taxes are not actually due until April 15, 2018, and I won't know the exact amount of the tax due until I complete the rest of my return. But the withheld pre-payments clearly are deductible in 2017. Why shouldn't the same reasoning apply to pre-paid property taxes? I'd like to see someone challenge the IRS advisory.

Posted by: Deborah Jones Merritt | Dec 29, 2017 12:52:14 PM

@Prof Merritt The reason is the intent of the legislation. The purpose was plainly to make certain taxes non deductible and the estimates were based on this assumption. By your logic, why not allow someone to pay their taxes for the next decade and deduct them in 2017? It's a clear effort to avoid the intent of the law which is being encouraged for political reasons.

Posted by: mike livingston | Dec 30, 2017 4:43:49 AM

They've never heard of the AMT?

Posted by: Moron | Dec 30, 2017 5:57:40 AM

Looks like more cases for me in the U.S. Virgin Islands thanks to the mirror code for U.S. Possessions. Hopefully the Department of Finance is not accepting early payments of the real property tax.

Posted by: Hugh Greentree | Dec 30, 2017 6:15:43 AM

I am for one tired of subsidizing high tax states. We who live in flyover country have been paying the taxes of these mochers for too long. Its time to pay up. Don't even think about moving we do not want you to come and poison our community with your liberal nonsense that has destroyed your cities and states.

Posted by: bearman | Dec 30, 2017 6:51:01 AM

In Illinois, Property Taxes are billed in the calendar year AFTER the original assessment. When a house is sold, calculations are made based on that fact. Plus, individual taxpayers operate on a cash basis. I believe that prepaid taxes should be deductible in the year that they were paid.

Posted by: Bob Brown | Dec 30, 2017 8:09:28 AM

I think I fall within the terms of Example 1. Even if the final guidance indicates otherwise, I prepaid. Taxes were assessed the end of Q3/17 and are due in full 3/31/18, By paying by 12/29/17, I get a 3% discount. Where else can I 'make' 12% per annum short term?

Posted by: Chuck Ritter | Dec 30, 2017 8:28:20 AM

If you can prepay 2018 taxes, why stop there? Why not 2019 and 2020, also?
Also, even without the limits on SALT deductions going forward, wouldn't people have incentives to prepay, since everyone's marginal rates are going down?

Posted by: brad | Dec 30, 2017 7:51:02 PM

The legislation made no mention of this issue. And the intent you think exists, is nowhere to be found. Read the bill. Read the explanation. The manifest intent matches up, quite precisely, with the text of the bill. And that is this: Only a pre-payment of state “income” taxes are specifically denied the deduction.

This issue isn’t something that has arisen “just because” of this new legislation. This issue has always existed. The posting by the IRS on its website doesn’t create tax law. It is merely the IRS’ opinion. And it is an opinion that may very well be wrong, given the case law on the matter. There is a Tax Court case (Hoffman; TC Memo 1999-395), where the Tax Court relied on a case called Hradesky (540 F.2d 821 (5th Cir. 1976) to conclude that property taxes must be assessed before they can be deductible. When you read Hradesky, however, that case said no such thing. Hradesky deposited funds with a third party to be used to pay his property taxes. Hradesky argued he got the deduction right then and there, even though the third party had not remitted the funds to the taxing authority. Further, within Hradesky, three cases were cited. One of them (Vasallo) involved excess profits taxes that were never even paid. Another (Galt) involved the same situation as Hradesky – funds were deposited with a third party and the third party had not remitted them to the taxing authority. The third case (Motel Corp) involved state income taxes. Some might say that when Hradesky cited a state income tax case, the implication is that there is no distinction between state income taxes and local property taxes, in terms of the federal itemized deduction. If that is the case, that’s real good news, since on this specific point, court after court has repeatedly held that paying state income taxes before they are assessed is quite okay so long as a few other conditions are met (e.g. the taxing authority agrees to accept the payment and the taxpayer has made a good-faith estimate of the taxes owed).

In all fairness, I will mention that Hoffman was appealed and the taxpayer lost. There were many issues in this case and the judge devoted only a few sentences to the issue at hand. In doing so, he cited Hradesky (which is an off-point citation for the reason noted above) and he also cited Lewis (which too, was an off-point citation as the facts were similar to Hradesky). I might add that the appellate decision in Hoffman was unpublished, which means it doesn’t create binding precedent in that (4th) circuit.

If this lineage of cases is what the IRS is basing its website Advisory on (we don’t know, they didn’t tell us), it is all scant support for its position.

“By your logic, why not allow someone to pay their taxes for the next decade and deduct them in 2017?”

Because there is existing tax law to prevent it. And by the IRS’ logic, consider this situation - we’ll use a 10-year period, just like you did (even though taxes are assessed on property on a single day): Local taxing authority assesses a $500,000 home at a 10% on December 31, 2017. This assessment will cover the calendar years 2018 – 2027, inclusive. Seems we’re okay with paying on 12/31/17 (since the taxes were assessed on that date, which is the IRS requirement)…and we’d be okay with taking a $50,000 deduction, right?

Posted by: Jeff | Dec 30, 2017 10:15:09 PM

@Ritter Your case strikes me as different facts. Don't cite me!

Posted by: mike livingston | Dec 31, 2017 3:05:04 AM