Franchise Tax Board may begin challenging the tax deductibility of parcel taxes -
Update: On April 13, 2012 the FTB reversed its position. Its guidance for taxpayers webpage (limiting the real property tax deduction, generally, to ad velorem taxes) has been taken down and new guidance will be coming. The FTB’s changed position may permit the deduction of Piedmont school parcel taxes, which average $3,000 per parcel. Check with your tax advisor. PCA Article coming soon. See FTB Update.
Many California homeowners may not realize that many charges on their property tax bills are not tax deductible – - but the IRS and Franchise Tax Board have plans to educate them. Starting in 2012, three lines may be added to California income tax returns asking homeowners for their parcel number, the amount of property taxes paid and the nondeductible amount.
Many homeowners deduct their entire property tax payment as an itemized deduction on their federal tax return. The deduction reduces state as well as federal taxes. But many “extra” assessments and parcel taxes included on the property tax bill are not deductible.
While the IRS has not targeted this issue in the past because it mainly affects California taxpayers, the California Franchise Tax Board is on a mission to get homeowners to stop deducting the entire amount of their property tax payment and hopes to raise California tax revenues substantially as a result.
The City of Piedmont is considering the possibility of providing advisory information on which local parcel taxes are tax deductible and which are not.
Deductible or Not? The General Rule
Generally, to be deductible a property tax charge must be based on a percentage of the home’s assessed value, known as an ad valorem tax. (It also must be imposed uniformly throughout the community and benefit the general community or government.) These ad valorem charges are listed on the left side of the property tax bill. (See sample bill below.)
In contrast, non-ad valorem charges are generally not deductible. This includes real property based charges for services, e.g. unit fees for water usage or trash collection. This also includes taxes assessed to provide a local benefit which tends to increase the value of property, e.g. assessments for undergrounding utilities and similar improvements. Non-ad valorem charges are listed on the right side of the property tax bill. (See sample bill below.)
Repair and Maintenance Exception
However, there is an important exception: local benefit taxes for the purpose of maintenance and repair (and related interest charges) may be deducted. This exception applies even if the tax or assessment is assessed on a non-ad valorem basis. Thus, parcel taxes based on lot size can be deductible in part or in whole when they are used for maintenance, repair, or related interest expense for local benefits such as sidewalks, streets, water lines, sewer lines, irrigation, and other similar improvement items. See FTB Guidance.
Impact on Piedmont residents
Special taxes and assessments levied on Piedmont residents are shown below.
School: The two school bond taxes are ad valorem and deductible. The two school parcel taxes (regular and temporary) are non-ad valorem and not tax deductible.
City: This parcel tax is non-ad valorem (based on lot size), but former City Attorney, George Peyton, asserted the city parcel tax was deductible in 2004 voter literature. No specific basis was provided for this position.
Sewer: Both the sewer tax and proposed surcharge are non-ad valorem (based on lot size), but may be deductible (at least in part) under the repair and maintenance exception. A portion of sewer parcel tax funds are utilized for ongoing maintenance, as well as repairs that are considered emergency work. A portion is used for sewer “rehabilitation” and related interest charges, but arguably could represent “repair and maintenance”, as well, since the work does not tend to improve property values.
Undergrounding: Assessments for undergrounding utilities through private utility districts are non-ad valorem. They are an elective, rather than necessary, expense intended to provide significant improvement to properties. They are not tax deductible.
Property taxes that cannot be deducted may be added to the basis of the property, if they tend to increase the value of the property.
PIEDMONT TAXES AMOUNT INCREASES TAX DEDUCTIBLE?
- school bonds (expire 2020) $80 per $100,000 0% DEDUCTIBLE
- school bonds (expire 2046) $20 – 60 per $100,000** 0% DEDUCTIBLE
- school parcel tax $2,021 to $3,678 5% ?
- school emergency parcel tax $219 to $372 0% ?
- private undergrounding $2,000+ 0% NO
- city parcel tax $342 to $576 CPI up to 4% ?*
- current sewer parcel tax $471 to 849 CPI w/o limit ?*
- proposed sewer surcharge $235 to $424 CPI w/o limit ?*
*May be tax deductible in whole or in part, depending on the extent to which revenues can be shown to be expended on repairs, maintenance or related interest expense.
For Piedmont residents, $2,000 to $4,000 in school parcel taxes will be non-deductible, as well as any private undergrounding assessment. An additional $3,000 to $6,000 in city/sewer parcel taxes are at risk of being non-deductible.
Will Deducting Piedmont Parcel Taxes Trigger an Audit?
Property tax bills do not designate which charges are and are not tax deductible. The Franchise Tax Board will launch an educational campaign in January and has posted some guidance for taxpayers. Alameda County has provided a sample tax bill which purports to identify which charges are generally not deductible – those on the right side of the bill. (See below.)
The Alameda County right/left guideline is not definitive: it ignores the exception for maintenance, repairs and interest which makes specific right side charges arguably deductible. But, as a practical matter, using the guideline may provide an informal “safe harbor” for taxpayers.
It is unclear whether the IRS and/or FTB may use the County sample tax bill to assert their initial position on Alameda County property tax deductibility for returns that are audited or, more importantly, use it to flag returns for audit. In a recent tax audit of a Piedmont resident, the tax deduction for Piedmont parcel taxes was disallowed.
In addition, the FTB asserts “To deduct the maintenance, repair, or interest part of a local benefit tax, you must be able to show the amount that is for maintenance, repair, or interest. If you cannot show what part of the local benefit tax is for these charges, you cannot deduct any portion of the local benefit tax.”
It is unclear if an individual taxpayer could adequately satisfy this burden of proof. An annual opinion from the City of Piedmont identifying the portion of its general and sewer parcel taxes dedicated to repair/maintenance may be helpful or necessary. City staff plans to explore this possibility.
The Big Picture
County property taxes are restricted to a 2% annual increase by Proposition 13 (subject to certain exceptions, such as sale). Cities are prohibited from levying any additional general ad valorem property taxes (even with a 67% vote), with the exception of school construction bonds. Municipalities have turned to many types of non-ad velorem parcel taxes and special assessments to create new revenue streams.
These additional parcel taxes and assessments may be based on a flat fee per household, an itemized charge for services assessed against specific property or certain people, parcel size, or other criteria. For convenience, lot size is often used. They can include charges for Mell0-Roos Districts, Community Facilities Districts, 1915 assessment district bonds, lighting and landscape, parcel taxes, school or college measures, water, sewer, flood, police, fire, libraries, emergency services, and more.
The City of Piedmont receives $1 million per year from its municipal parcel tax, $2 million per year from its current sewer tax, and hopes to receive an additional $1 million per year for 10 years from a proposed new sewer surcharge which will be voted on February 7, 2012. This represents $4 million in potentially non-deductible taxes for Piedmont residents.
The Piedmont Unified School District receives $9 million per year from the regular school parcel tax, plus $1 million from the temporary emergency 3-year school parcel tax which expires as of June 2012. This represents $10 million in non-deductible taxes for Piedmont residents. Reducing a homeowner’s property tax deduction by $3,000, the average, can result in about $1,000 in additional taxes.
One tax expert has suggested tax deductibility may not be a significant issue for taxpayers subject to alternative minimum tax: they have already lost all or part of their property tax deduction.
**The new 2006 school bonds are currently levied at $20 per $100,000, but will rise to $60 per $100,000 when the $80 for older school bonds (used to build the existing High School years ago) are retired in 2020.
LINK: View your tax bill
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