Are Taxes on Property Deductible?

When tax season arrives, homeowners often wonder whether they can deduct property taxes from their taxable income. Property taxes are a significant expense for many, especially in areas where real estate values are high. Fortunately, in many cases, property taxes are indeed deductible. However, the rules governing these deductions are specific, and understanding them can help maximize potential tax savings.

What Are Property Taxes?

Property taxes are levies imposed by local governments on real estate owned by individuals or entities. These taxes are typically used to fund public services like schools, roads, and emergency services. The amount of property tax owed is usually based on the assessed value of the property, which is determined by the local tax authority. Homeowners receive a property tax bill annually, and the payment is often included in mortgage payments, where the mortgage lender then pays the taxes on behalf of the homeowner.

Property Tax Deductions and the IRS

Under U.S. tax law, property taxes on real estate are considered a deductible expense. This means that taxpayers can subtract the amount of property taxes paid from their taxable income, potentially lowering their overall tax liability. However, the deduction is subject to several limitations and conditions, particularly after the passage of the Tax Cuts and Jobs Act (TCJA) in 2017.

The SALT Deduction Limit

One of the most significant changes introduced by the TCJA was the cap on the State and Local Tax (SALT) deduction. The SALT deduction allows taxpayers to deduct property taxes, as well as state and local income or sales taxes. Before the TCJA, there was no cap on this deduction. However, starting in the 2018 tax year, the SALT deduction was capped at $10,000 for single filers, married couples filing jointly, and heads of households, and $5,000 for married individuals filing separately.

This cap means that if the total of your state, local, and property taxes exceeds $10,000, you can only deduct up to that amount on your federal tax return. For many homeowners in high-tax states, this cap significantly reduces the value of the property tax deduction.

What Property Taxes Are Deductible?

To claim a deduction for property taxes, the IRS requires that the taxes must be:

1. Ad Valorem: The tax must be based on the value of the property. Assessments based on improvements to the property or specific benefits received, such as a new sidewalk or streetlights, are generally not deductible.

2. Levied for the General Public Welfare: The tax must be used for general public purposes, such as funding local government operations, and not for services that only benefit your property.

3. Paid During the Tax Year: The deduction applies to property taxes actually paid during the tax year. If you pay your property taxes through an escrow account with your mortgage lender, you can only deduct the amount the lender paid to the tax authority during the year, not the amount you paid into the escrow account.

Non-Deductible Property Taxes

Not all property-related taxes and fees are deductible. For instance, taxes or assessments used to build or repair local infrastructure, such as sidewalks, water lines, or sewer systems, are not deductible. These are considered betterments or improvements, which increase the value of the property and may be added to the cost basis of the property rather than deducted as a tax.

Additionally, any part of your property tax bill that is for services such as trash collection, water, or sewer is also non-deductible. These are viewed as fees for services rather than taxes.

Special Considerations

For those who own multiple properties, it’s important to note that the SALT cap applies to the total of all state and local taxes paid, not to each property individually. This means that owning additional properties in different states may not increase your deductible amount.

Furthermore, property tax deductions are only available if you itemize your deductions on your federal tax return. With the increased standard deduction under the TCJA, many taxpayers find that itemizing deductions is less advantageous than taking the standard deduction.

Property tax deductions can offer significant savings for homeowners, but they come with certain limitations, particularly the $10,000 SALT deduction cap. Understanding what qualifies as a deductible property tax and how to properly claim the deduction can ensure you take full advantage of the tax benefits available to you. For those with substantial property tax bills, consulting a tax professional is often advisable to navigate the complexities of the deduction and maximize your tax savings.