In determining what is tax-deductible, the answer is frequently “maybe,” instead of either “yes” or “no,” to any question that begins with “Can I deduct…” This includes the topic of real estate taxes, where the answer is still “maybe.” When the subject of deductible real estate taxes is discussed, it is primarily about those taxes connected to a personal residence. However, it should be noted that real estate taxes are assessed by state and local level taxing agencies on any real property within the agency's territory and must be paid by those having an ownership interest in that property to be deductible.
Generally, the local tax assessor’s office issues a bill payable in two installments for the assessment tax year. The assessment tax year does not always align with a calendar year. Thus, it is important to note that any real estate taxes that would qualify for a deduction must be paid in the tax year they are to be deducted. A quick break down of real estate taxes will illustrate that they fall into various categories such as follows:
- Annual assessment (ad valorem) – amount assessed based on the property’s value (funds used primarily for the general public or governmental purposes).
- Special assessments – amounts assessed on a direct charge against the property, not based on values (funds are not used for the general public at large).
- Special services assessment – amounts assessed to specific property owners to receive the direct benefit of the project for which the assessment was levied. (Example – construction of new sidewalks in a specific neighborhood.)
How is the Real Property Used?
Now, after taking note of what a real estate tax assessment can consist of, the next consideration is how the real property is used. In other words, is the real property a taxpayer’s primary residence, second home, rental home, or commercial property used in a trade or business? How real property is used determines how much of the taxes assessed can be deducted, if any. Also, it determines where on a tax return that deduction can be taken.
Property Used for a Trade or Business
Generally, the real estate taxes assessed against property used in a trade or business are tax-deductible for the trade or business activity. For example, if you have a residential rental property, then the real estate taxes are deducted from the gross rents received to determine the rental activity’s net income. Or, suppose you rent out a commercial building. In that case, the real estate taxes are deducted from the gross rental income to arrive at the net income from the rental. The full real estate tax assessment would generally be deducted on Form 1040, Schedule E, in both of these examples. If the property is a commercial building owned by another entity in which you have an ownership interest, such as a limited liability company, the full tax assessment would be deducted on the tax return for the business.
Property Used for a Non-trade or Business
For real estate taxes assessed on non-trade or business property, the tax deduction can be limited. Multiple factors must be considered concerning the potential limitations of the tax deduction. Those factors include ownership interest, nature of the tax assessment, and overall SALT (State and Local Income Taxes) limitations for those itemizing their deductions.
First, consider the limitation on the total dollar amount claimed for SALT taxes during tax years 2018 to 2025 due to The Tax Cuts and Jobs Act (TCJA). Under this law, all taxes eligible for deduction as defined under the tax code provisions and classified as SALT taxes cannot exceed $10,000. An example would be someone with $12,000 of deductible real estate taxes and no other SALT taxes; the deduction would be limited to $10,000 based on the provisions set forth under the TCJA. Taxpayers will be limited to a $10,000 deduction for tax years 2018 to 2025 even if they have a combination of SALT taxes that exceed $10,000, such as both property taxes and state income taxes.
Second, consider the ownership interest aspect of the real estate tax deduction. As noted, real estate taxes are assessed to those who possess an ownership interest. Ownership interest generally rests in the hands of the individual, persons, or entity listed on the legal title to the property in question. Thus, an owner of real property has the rights and control over the property. Please note, someone can have what is known as an “equitable” ownership interest in real property that would allow them to claim any deductible real estate taxes, even though the title is not listed in their name. An individual must both pay the tax assessments and be allowed to treat the property as though they were the legal owner to have an equitable ownership interest. This is sometimes referred to as the ‘benefits and burdens” of ownership. Any individual with equitable ownership would lack the right to transfer the property title without the actual titleholder’s consent.
Lastly, consider the limitation on the deduction caused by the nature of the assessment. In general, the amount of the real estate taxes assessed based on value (ad valorem) would be eligible for the deduction. The ad valorem portion of real estate taxes is normally assessed on all property owned in the taxing authority’s territories at the same rate, and are used for the general public’s welfare. Portions of the assessment related to the maintenance of sidewalks and public infrastructure may also be allowed as a deduction. However, the burden of proof lies with the property owner. Assessments related to services are not deductible, nor are special assessments that are not based on the value of the property.
Real estate taxes can be eligible for a tax deduction on Schedule A, Itemized Deductions, when they meet all the following requirements:
- Taxes must be levied against the real property based on the property's value at the same within the territory.
- Taxes are levied on the property, not the property owner (owner is liable for payment).
- Taxes are imposed by ownership, not the use of the property.
Taxpayers can typically use the tax bill's detailed information from the local assessor’s office to determine the deductible amounts. As a reminder, the amounts must have been paid to the assessor in the year claimed. In cases where the real estate taxes are paid through an impound account, the lender generally reports the amount paid to the assessor on Form 1098. Or, the information may be obtained from the year-end billing statement from the lender. A deduction cannot be claimed based on the total paid into the impound account from the property owner to the lender, as the amount does not necessarily reflect the amount paid to the taxing authority.