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When Property 'Taxes' Are NOT Deductible on Schedule A of Form 1040

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Feb 17th 2015
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Individuals who itemize deductions for state and local taxes use Schedule A of the Form 1040 to claim such write-offs. They use Schedule C and Schedule E, respectively, to deduct taxes on property used in a business or on property that produces rental or royalty income. Deductible levies for itemizers include income taxes, sales taxes, real estate taxes and personal property taxes. But those write-offs come with strings attached as to which ones qualify, when they’re deductible and how much of a deduction is allowable. You have to know the fine points.

To illustrate, real estate taxes usually mean any state, local, or foreign taxes on real property. But a special rule applies when a portion of your monthly mortgage payment goes into an escrow account and the mortgage company periodically pays your real estate taxes to local governments out of this account. The measure of the allowable deduction is the amount actually paid during the year to the taxing authorities. Typically, lenders will send yearend statements that show this information.

Another stipulation is that the IRS allows deductions only for taxes paid on real estate. The IRS reads the law as requiring the taxes to pass a two-step test:

  1. The taxes are based on the assessed value of the real property.
  2. The assessment is charged at a uniform rate against all property under the jurisdiction of the taxing authority—an approach that generally forbids deductions when the taxes in question are charged for local benefits and improvements that tend to increase the value of your personal residence.

IRS regulations list the prohibited charges. They include assessments for construction of streets, sidewalks, water mains, sewer lines, public parking facilities, and similar improvements. But all is not lost. Those assessments are added to your home’s cost basis—the figure used to determine gain or loss on a later sale. When does the agency authorize current deductions for local benefit taxes? Only if they’re for maintenance or repairs of streets, sidewalks, or other local improvements, or interest charges on such maintenance.

Other verboten deductions are itemized charges for services, even if characterized as “taxes.” Some common examples are unit fees for delivery of services (water consumed), periodic charges for residential services (trash collections) or flat fees for single services provided by your government, such as a charge for mowing your lawn because it was allowed to grow higher than permitted under your local ordinance.

Another snag is the alternative minimum tax. It disallows all itemized deductions for state and local taxes.

About the author:

Julian Block writes and practices law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator) and an attorney. More on this topic is available from “Julian Block’s Year Round Tax Strategies,” available at julianblocktaxexpert.com.

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