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IRS warns property tax prepayments must be properly assessed

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The IRS offered a very timely warning to those 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 Berdon. “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, [New York], for instance, school taxes for first half of 2018 have been assessed and warranted – and for many people, that’s 70% of your property tax.”

The newlyl signed tax overhaul reduces 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 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 2018-19 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 2018-19 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 2018-19 tax year until July 1, 2018.

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 on their federal returns (though not necessarily on state returns) — 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 announcement: “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.

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.

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