Writing Off Property Taxes from your Income Tax Returns

The U.S. median home price is now rapidly approaching $400,000, which also translates into a median annual property tax bill of $4,440. Homeowners in the Deep South can expect to pay an effective property tax rate of less than one percent, while high-tax California, Illinois, and Northeast homeowners are taxed at 2.5%.

At these levels, upper middle-class residents might easily fork over $10,000 in property taxes per year. For relief, property taxes may be treated as deductible expenses. Now, it is the 2017 Tax Cuts and Jobs Act, colloquially known as the Trump Tax Reforms, that frames much of this ongoing debate.

Owner-Occupants and Investors

Owner-occupants may write off property tax expenses from their primary residences and second, vacation homes. Investors will claim property taxes as a business expense to lower taxable income.

Homeowners must familiarize themselves with standard versus itemized deductions, as they relate to primary and second home tax filings. For 2023, standard deductions are $13,850 for single and married filing separately, $20,800 for head of household, and $27,700 for married filing jointly taxpayers.

Here, it is either or, and we will only itemize deductions that total up to more than the standard deduction. Itemized deductions include medical expenses above 7.5% of your adjusted gross income, state and local taxes, gifts to charity, and theft losses.

Itemized state income and local property tax (SALT) deductions are now limited to a combined $10,000, as part of the 2017 Tax Cuts and Jobs Act. This SALT legislation, again, is especially problematic for high-tax California, Illinois, and the I-95 Northeast megalopolis cities and states.

Organize, Prepare, and File Tax Paperwork

Mortgage lenders that collect interest and manage escrow accounts on your behalf will submit the Form 1098 – Mortgage Interest Statement to both the IRS and your address of record by January 31 of the following calendar year and immediately prior to the start of tax season.

Form 1098 lists out mortgage interest and insurance premiums received; above real estate taxes paid for the tax year. Individuals and entities who pay property taxes directly to county treasuries must review their own banking records.

Complete Schedule A – Itemized Deductions to account for property taxes and interest paid on personal residences and second homes. Here, Form 1098 property tax information is entered directly into the Taxes Paid section. Schedule A language warns that state and local income and property taxes are limited to $10,000.

We take property tax deductions, only if total itemized deductions are greater than your standard deduction. We subtract your standard or itemized deductions away from adjusted gross income to arrive at taxable income.

Now, seven separate tax brackets will levy at 10%, 12%, 22%, 24%, 32%, 35%, and 37% rates, according to your income. Single filers reporting $578,126 ($693,751 for married filing jointly) or more in taxable income occupy the highest bracket.

Be further advised that itemized deductions expose higher income taxpayers to the alternative minimum tax (AMT), which is a parallel tax code. Onyx Investments will complete Form 6251 – to determine whether you will be responsible for AMT.

Real Estate Investors

Real estate investors will deduct property taxes as a business expense. As with any investment, tax paperwork relates to business structure. A pass-through entity is directly included as a part of personal income before being taxed, while a regular corporation is actually taxed twice, at the corporate and personal level.

Sole proprietors, along with S-Corporation and LLC partners will file Schedule E Supplemental Income and Loss to account for property taxes on rental real estate. From here, we include Schedule E totals with Schedule 1 Additional Income, before entering this information directly onto the 1040 Individual Income Tax Return.

Onyx completes and files Form 1120 to document property tax expenses for regular C Corporations, which are treated as separate, taxable entities. The tax rate is now a flat 21% for corporate income.

From here, investors are still responsible for paying personal income taxes on their own share of dividends and capital gains, which amounts to double taxation.

State Income Taxes

All fifty states will present their own interpretations of the income tax code. In California, all property taxes paid may be itemized through Schedule CA. The majority of states, however, restrict property tax deductions to primary residences and business real estate owned within their own particular borders.

We file Schedule ICR to take nonrefundable credits for the very much maligned, besieged, and beleaguered Illinois taxpayer. Springfield does allow for a 5% dollar-for-dollar property tax credit.

Financial Strategy

For Onyx, our ultimate goal remains to maximize client returns, while also mitigating downside financial risks. Serious investors immediately realize that alpha total returns do not necessarily translate well into minimal tax bills.

We consider high property taxes to be the cost of doing business in hot markets. Even Texas, with no state income taxes, levies notoriously high property taxes to help finance any assumed budget shortfalls.

Still, Onyx Investments will readily acknowledge the ongoing migratory shifts out of California and the industrial North, into the Sun Belt States, for lower taxes and costs of living. Web 2.0 technologies, COVID-19, and cheap money brewed the perfect storm to usher us all into the work-from-home movement and accelerate frantic bidding wars throughout rural America.