Understanding Real Estate vs Personal Property Tax
Property tax is generally divided into two categories—real estate tax (sometimes termed real property tax) and personal property tax—and there are significant differences between the property tax categories in how the taxes are determined. Whether a property tax is deductible for income tax purposes depends on whether the property is used for business, investment or personal use. Property tax is generally levied on tangible property, i.e., property you can actually touch, as opposed to intangible property such as copyrights, trademarks, business goodwill and patents.
Real Property Taxes
Real property taxes apply to property that is land as well as immovable man-made improvements to land such as buildings. Generally, the tax is a percentage of the property’s current fair market value (FMV) based upon an appraisal by the taxing authority that takes into account the value of the property’s land and improvements. Property owners can dispute the taxing authority’s appraised value , but they bear the burden of proof for a lower appraised value. In some jurisdictions, the most recent sale price of the property resets the value that is subject to tax, and any increase in value in subsequent years may be limited to a percentage set by law.
Real property taxes are only tax deductible if they are assessed equally against all property by the local governmental tax collector. The taxes collected must be used for general public or government purposes and not specifically for the property owner or for services provided to the property owner, such as trash collection.
Property taxes can be incurred personally or in the course of business. When incurred personally, they are deducted as an itemized deduction on Schedule A under the general category of “taxes.” The most commonly encountered property tax is the tax on an individual’s home or second home(s). (Note: unlike mortgage interest, the tax deduction is not limited to only first and second homes.) Don’t forget: if you don’t itemize your deductions and instead take the standard deduction, you get no tax benefit from the taxes that would have been deductible on Schedule A. (If you need additional help contact a Miami CPA for assistance).
Deductible real estate tax generally does not include taxes collected to provide special benefits to the property owner or that will increase the value of owner’s property. Examples would be public parking facilities, water mains, sewer lines, streets, sidewalks and comparable property improvements. Those types of taxes are added to the property’s basis. Local benefit taxes are only deductible if they are for maintenance, repair or interest charges related to those benefits. For buyers looking for a new home, it may be wise to create a home buying tax deduction checklist.
Charges for Services
Itemized charges for services, such as a monthly fee for trash collection and per unit charges for water service, are not deductible if the assessment is on a primary residence or second residence, but would be deductible if the taxes are assessed on a business or investment real property. There is an exception for service charges used to maintain or improve services (such as trash collection or police and fire protection), which are deductible as real estate taxes if:
- The fees or charges are imposed at a like rate against all property in the taxing jurisdiction;
- The funds collected are not earmarked but are instead commingled with general revenue funds; and
- The funds used to maintain or improve services are not limited to or determined by the amount of these fees or charges collected.
Alternative Minimum Tax
Another snag to watch out for is the alternative minimum tax (AMT). The AMT is another way to compute an individual’s income tax and was originally designed to limit certain deductions for high-income taxpayers. But with years of inflation, it also now applies to many middle-income individuals. Schedule A taxes are one of the deductions limited (not allowed) by the AMT. Thus, to the extent that a taxpayer is subject to the AMT, he or she gains no tax benefit from a Schedule A tax deduction. However, there is one ray of sunshine. If the taxes are on unimproved and unproductive real estate, the owner may elect annually to capitalize (add to the property basis) the property taxes instead of claiming them as a deduction.
Who Can Deduct?
Just because an individual pays a property tax does not mean that he or she gets to deduct it. Generally, the one paying it must also be the individual upon whom the tax is imposed in order to deduct it. If an individual is only a part owner of a property but pays the entire tax, then the individual is entitled to deduct the entire amount. On the other hand, if someone decides to help a relative or friend in need by paying their property tax, the Good Samaritan can’t deduct the tax because the tax was not imposed upon him or her, and the friend or relative can’t deduct it either because they didn’t pay the tax. A tax-strategy workaround would be to gift the friend the money and have them pay the tax bill, so that at least they can get the deduction (if they itemize their deductions). Take note, however, that gifts to each individual in excess of $14,000 each year are subject to gift tax reporting.
Minister or Member of the Armed Forces – Ministers or members of the uniformed services who receive an excludable housing allowance can still deduct the real estate taxes they pay on their main home on Schedule A of their tax return, even though the housing allowance is tax-free.
Business Property Taxes – If real estate property taxes are imposed on rental real estate, the taxes would generally be included as an expense item on an individual owner’s tax return on a Schedule E and added into the mix of other deductions to offset rental income. The resulting gain or loss is reported on the return, subject to certain loss limitations. If the rental real estate is owned by multiple parties, the real estate property taxes are deducted on the business entity’s tax return, and in the case of a partnership or S corporation, the individual’s gain or loss is passed back through a Schedule K-1 to the individual’s tax return.
Investment Property Taxes – The property taxes paid by an individual on investment property (or the individual’s share, if the property is owned by multiple individuals) is also deductible on the individual’s Schedule A, subject to the same limitations that apply to other Schedule A deductible taxes.
When are they deducted?
Many taxing jurisdictions use a fiscal year for real property tax purposes. For example, a tax bill may say that it is for the July 1, 2016–June 30, 2017 period. Most jurisdictions allow individuals to pay their real property taxes in two or more installments without penalty if made timely. For example, the taxpayer may make one payment in 2016 for their 2016–2017 tax bill and a second payment in 2017 for the balance of the bill. So, when are these payments deductible? For individuals, only the taxes actually paid during the tax year are deductible. This actually allows for a bit of tax planning. In a year of high income, an individual may wish to pay the second installment of the prior fiscal year and both installments of the current fiscal year all in one tax year to boost his or her deductions in the high-income year. However, care should be taken to ensure that there is not an AMT issue that year.
Personal Property Taxes
Personal property is property other than real estate property, generally movable manmade objects. Personal property tax is imposed on personal property used in business and that is used by individuals personally, which for tax purposes is called personal use property.
Cars, boats, and aircraft come to mind when we think about taxes on personal use property. Many taxing jurisdictions will combine registration fees and personal property tax in the same billing. Only the personal property tax portion is deductible, so it must be separated from the other fees to be deductible on Schedule A as a tax if the individual is itemizing his or her deductions. The tax is a percentage of the market value of the personal property, which is determined by a formula established by the taxing jurisdiction. If the tax is based on something other than value—for example, the weight of a vehicle—then it is not deductible as a Schedule A tax.
When it comes to personal property taxes for business, the tax is not just limited to cars, boats, and aircraft. It includes virtually every item of personal property owned by a business, including computers, printers, furnishings, communications equipment, and machinery.
At first glance, taxes may seem simple, but as you can see, they can also be quite complex. There are a number of tax planning strategies that you can employ for your benefit. Thanks again to Taxbuzz.com, our go-to partner for all tax-related information.