This story has been updated with new details about Internal Revenue Service guidance on prepaying property taxes and other changes to clarify how people should think about the property tax deduction.
On Wednesday evening, the Internal Revenue Service released guidance on who can prepay 2018 property taxes, saying taxpayers could do so only limited circumstances: If the local tax authority has already told a taxpayer how much they owe in property taxes for 2018, and if the taxpayer makes payment on what they owe before the end of the year. The guidance came after people around America had already rushed to prepay property taxes in hopes of taking full advantage of the property tax deduction one last time before the new Republican tax bill, signed into law last week by President Trump, takes effect Jan. 1. The bill limits the value of the deduction.
Many taxpayers remain confused about whether they are eligible and how they can take advantage of the tax break. Here are some basic questions and answers about what’s going on — with the caveat that every taxpayer’s situation is different and, if possible, it’s best to consult a tax professional who can assess your circumstances.
What are the basic issues involved?
On Dec. 22, Trump signed into the law the new Republican tax bill overhauling the tax code. A key provision of the bill modifies a long-standing tax break that allowed individuals to deduct from their federal taxable income any state and local taxes paid that year, including real estate or property taxes.
The new bill only lets people deduct up to $10,000 in state and local taxes, including property taxes. For instance, a household that pays $8,000 in property taxes and $12,000 in state and local income taxes currently can deduct $20,000 from their federal taxable income. If they pay an average 20 percent tax rate, that means they would save $4,000 on their overall tax bill thanks to the deduction.
But in April 2019, when they file their 2018 taxes, they could claim just $10,000 in state and local tax deductions. For simplicity's sake, if they are still paying a 20 percent tax rate, now they would save just $2,000 off their tax bill. (Authors of the bill say that for most people, the deduction’s reduced value is well offset by other beneficial provisions of the new law, including lower federal tax rates.)
This is the new system most Americans will operate under in the years to come. But some taxpayers might have had a way to save a bit more when they file their 2017 tax returns this coming April. That’s because some states and localities allow people to prepay their state and local taxes, including property taxes. If they did so this year, people could conceivably deduct them from this year's taxes.
Authors of the new tax bill were aware of this possibility, so they prohibited people from prepaying their state and local income taxes (if you make quarterly tax payments, you can pay your fourth-quarter tax payment, usually due in January, this month). But they did not include similar language for property taxes. Which is why homeowners around the country are now rushing to see whether they can pay those taxes now and deduct them on their 2017 return.
Can I ignore this?
Yes! If you don’t itemize your tax deduction (and most Americans don't), it will have no benefit for you.
If you pay less than $10,000 in state and local taxes, it may not have any benefit for you. That depends on whether you itemize your taxes today, but don't expect to itemize your taxes next year thanks to a new and enlarged standard deduction worth $24,000 for a married couple. If that's your position, prepaying might still make sense. If not or it's a close call, it might not be the worth the hassle.
And, of course, according to new IRS guidance released late Wednesday, if your local tax authority has not yet informed you of what property taxes you owe in 2018, you can't take advantage of the maneuver.
You can also ignore prepayment if you don’t want to be bothered by it.
To figure out how much you pay in state and local taxes, pull out a copy of last year’s tax return and look at Schedule A on Form 1040. Look at lines 5 and 6 (state and local taxes and real estate taxes) and add them together. Lines 7 and 8 — involving other taxes you might have paid — might be also be relevant, but they affect fewer people.
According to the Tax Policy Center, 86 percent of families earning $200,000 to $500,000 claim a property tax deduction, and the average value is $8,155.
Who should do it?
In general, people who stand to benefit most are people who itemize their tax deductions and pay substantially more than $10,000 in state and local taxes, including property taxes, and have already received a 2018 property tax assessment.
It's particularly relevant in places in states and localities with higher income tax rates and property tax rates. That includes large swaths of the Northeast, the West Coast, parts of Florida and a number of major cities throughout the country.
But there is one important caveat:
People who pay the alternative minimum tax don’t qualify for the state and local tax deduction. The alternative minimum tax is essentially a parallel tax system that mainly affects six-figure earners who take a lot of deductions. The AMT tries to make sure these earners aren’t able to skimp on their federal taxes by too much.
Not sure if you pay the AMT? Check line 45 of last year’s 1040. About 4 ½ million taxpayers pay the AMT, and most make more than $200,000 a year.
Note: If you’re a six-figure earner and you made a bit more money this year, or qualify for a lot more in deductions, you might be affected by the AMT in 2017 and not know it yet. It’s hard to figure this out ahead of time, but you can try with the IRS's AMT Assistant.
So, how do I do this? What if I pay my property taxes through my mortgage lender?
First, it depends on whether your locality will allow it and whether they have told you what you owe in 2018 property taxes. Here’s information for the Washington region. For others, check with your local tax office.
Next, if you pay your property taxes through your mortgage lender, as many Americans do, you should check with your lender. Some will ask you to prepay your property taxes and then follow up with them in 2018. Once the bank confirms that your 2018 property taxes are paid, they will refund you any money held in escrow and adjust your monthly mortgage payments.
Again, it’s important to check with your lender.
So what should I do?
If you are certain you have received a tax assessment and qualify to prepay the property tax deduction, it might be well worth it.
What if I already have?
Many taxpayers prepaid their taxes before formal IRS guidance was issued on Wednesday evening, so now there may be a rush to see whether those payments will be deductible. If not, the question will be whether localities will be in a position to cancel or refund those payments. This could be a big point of contention between residents and local governments, and it wasn't immediately clear where this would be an issue or how local governments respond.
Anything else I should be aware of?
Prepaying property taxes might be just one way to adjust your personal financial situation before the end of the year.