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Tax Cuts and Jobs Act – Non-business Tax Limits

The Mangold Group, CPAs is informing you of the new limit placed on individuals’ itemized deductions of various kinds of non-business taxes, which was made by the massive Tax Cuts and Jobs Act (the Act), effective beginning with the 2018 tax year.

Before the changes were effective, individuals were permitted to claim the following types of taxes as itemized deductions, even if they were not business related:

(1) state, local, and foreign real property taxes;
(2) state and local personal property taxes; and
(3) state, local, and foreign income, war profits, and excess profits taxes.

Taxpayers could elect to deduct state and local general sales taxes in lieu of the itemized deduction for state and local income taxes.

Tax deduction cuts. For tax years 2018 through 2025, the Act limits deductions for taxes paid by individual taxpayers in the following ways:

. . . It limits the aggregate deduction for state and local real property taxes; state and local personal property taxes; state and local, and foreign, income, war profits, and excess profits taxes; and general sales taxes (if elected) for any tax year to $10,000 ($5,000 for marrieds filing separately). Important exception: The limit doesn’t apply to: (i) foreign income, war profits, excess profits taxes; (ii) state and local, and foreign, real property taxes; and (iii) state and local personal property taxes if those taxes are paid or accrued in carrying on a trade or business or in an activity engaged in for the production of income.
. . . It completely eliminates the deduction for foreign real property taxes unless they are paid or accrued in carrying on a trade or business or in an activity engaged in for profit.

To prevent avoidance of the $10,000 deduction limit by prepayment in 2017 of future taxes, the Act treats any amount paid in 2017 for a state or local income tax imposed for a tax year beginning in 2018 as paid on the last day of the 2018 tax year. So an individual may not claim an itemized deduction in 2017 on a pre-payment of income tax for a future tax year in order to avoid the $10,000 aggregate limitation.

Before 2017 year comes to an end, many individuals are considering prepaying their 2018 property taxes (that ordinarily are assessed in October 2018 and due by January 31, 2019) in 2017, if doing so would not subject to the alternative minimum tax. By prepaying 2018 property taxes in 2017, many believe they can increase their tax deductions for 2017 and prevent limitations to their 2018 property taxes if they were paid in 2018.

For Travis county residents, please see https://tax-office.traviscountytx.gov/properties/payment-options for payment options and instructions. For other counties, you should consult your local taxing authority to determine whether these prepayments will be accepted. Travis County has indicated that their acceptance of the payment for 2018 is only as an escrow deposit. The IRS has been clear that amounts held in escrow are not deductible until the actual assessment against which those funds are held has been made. Therefore, payments made to Travis County for 2018 property taxes prior to the assessment of those taxes for 2018 are not properly deductible on a 2017 income tax return.

Even if your county does not call it an escrow or has some form of application for early assessment, the Treasury Department and IRS have broad discretion to make regulations under the Internal Revenue Code and there is a very good chance that they will find a way to close this loophole before 2017 returns get filed, or deny deductions taken on 2017 returns for amounts that are effectively treated as escrow payments against taxes which have not yet been assessed.

So, although you will not lose money paid to the county by prepaying your property taxes since they would be due anyway by January 31, 2019, the deduction you are planning to get for the prepayment may vaporize (or be limited to the $10,000 maximum) if the IRS decides that they have justification for preventing people from taking it. Choosing to take the deduction for early payment of property taxes, while not clearly disallowed under the new law in some cases, could subject your return to examination, resulting in at least some inconvenience and fees for our representation and amendment of the return, in addition to late payment penalties and interest. Whether to take that risk is a personal decision you must make. If you determine that you want to prepay your 2018 property taxes, you should write a separate check for your 2018 taxes, designate on your check the tax account number associated with the property, and notate that it is a payment for 2018. The check should be postmarked or received before December 31, 2017.

It is also important to note that this limitation only applies to property taxes on real estate held for PERSONAL use. Property tax payments for BUSINESS personal property and BUSINESS real estate and RENTAL real estate will not be affected by the tax law change and will continue to be deductible against business or rental income as under prior law.

I hope this information helps you understand these changes. If you would like to engage us to determine how this or any other aspects of the new law applies to your specific situation, please give our office a call to set up a planning or projection service appointment to explore the planning steps you might consider in response to them.

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