IRS Slams Door on Property Tax Workarounds

One of the more contentious provisions of the 2017 Tax Cuts and Jobs Act (TCJA) was a new ceiling on the SALT deduction.  This is the amount taxpayers can deduct on federal tax returns for what is paid in state and local taxes including income, sales, and property taxes.  The new limit is $10,000 where previously there was none.  The increase in the standard deduction included in TCJA meant most taxpayers are better off not itemizing SALT and other Schedule A deductions and the change is also is expected to bring the Treasury an additional $36 billion in revenue this year, reaching $90 billion by 2024.

However, the SALT deduction has been an important one for those homeowners of high value properties living in states where property taxes are also high and to those with second homes. George King, an analyst with CoreLogic's Government, Risk Management division, writes in the companies blog that the passage of TCJA near the end of last year sent many of those who would be affected scurrying to their tax collector to prepay their 2018 property taxes before the New Year's ball dropped so as to take the SALT deduction one last time on their 2017 returns. CoreLogic data shows that prepayment activity increased by 90 percent in California and by 300 percent and 191 percent in New Jersey and Massachusetts respectively.  However, IRS has warned that these prepayments may be allowable only under certain circumstances.

Both taxpayers and those states most heavily impacted are seeking a way out of the "unintended" consequences of the tax act.  Four states, Connecticut, Maryland, New Jersey and New York are suing to strike down the $10K cap and are asking the courts to declare it unconstitutional.

Several states are following the lead of New York which has amended its own tax law to authorize school districts, county governments, and New York City to establish charitable funds which would provide a credit for taxpayers of up to 95 percent of donations those funds. The credits can be applied against property taxes. Connecticut and New Jersey have since passed similar charitable funds bills, which both went into effect in early July and a bill is pending in California and possibly in Illinois.

Needless to say, the IRS is looking somewhat askance at these state workarounds and has announced that it and the U.S. Treasury will be issuing guidance on the issue. One subsequent notice from IRS has reinforced that federal law controls the characterization of payments for federal income tax purposes regardless of how state laws may characterize them.

Last month IRS opened public comment on a proposed regulation that holds that all contributions claimed for purposes of charitable deduction must be reduced by the amount of corresponding credits received.

The comment period expires on October 11. King says should the proposed rule go into effect it would pretty much negate the states' attempts to get around the SALT cap.  It would, he says, 'be bad news for those who itemize their tax deductions and may consider moving out of high property tax areas." However, he adds that lenders would avoid the anticipated mortgage loan administration challenges as they try to determine the correct amount to escrow for borrowers' accounts each year."