Did you report nondeductible taxes on your 2011 return?

  • No (79%, 41 Votes)
  • Yes (21%, 11 Votes)

Total Voters: 52

This article examines the FTB’s recent attempt to enforce property tax deduction limitations for 2012 state tax returns – and the backlash from the IRS and some members of the California Assembly.

The loophole

California presently conforms to federal income tax deductions for property taxes, allowing deductions for ad valorem taxes paid by homeowners. Ad valorem taxes areset based on property values determined by county assessors.

However, many homeowners get away with taking deductions based on that the total payment made each year to the county tax collector, which often includes other monetary obligations,such as:

  • improvement district assessments;
  • Mello-Roos bonded indebtedness; and
  • direct levies, fees and charges that are clearly not ad valorem taxes.

Sneaky, unaware or misinformed homeowners have been getting around the property tax distinction due to an unintended loophole in auditing created by the California Franchise Tax Board’s (FTB’s) past inability to distinguish whether the deduction of the total payment to the tax collector is only for property taxes or includes items other than property taxes.

Increased taxes?

The FTB estimates it will bring in an additional $200 million each year by enforcing these rules.

This would have affected those with Mello-Roos bond payments and special assessments. In practice, the misconception that Mello-Roos payments are included in homeowners’ tax deductions arises from the oft-used California Association of Realtors (CAR) purchase agreement form. It improperly lists Mello-Roos payments in the same provision covering the payment and proration of property taxes. first tuesday’s purchase agreements properly list Mello-Roos principal amounts as an improvement bond lien on the property, a principal debt equivalent to a trust deed lien and clearly distinct from the treatment given property taxes. Further, CAR offers no form for property tax benefits of ownership; first tuesday encourages use of a federal income tax liability form after completing a home sale. [see first tuesday form 351]

Related article:

[See first tuesday form 150]

However, these efforts were stymied this month as the Internal Revenue Service (IRS) stepped in to clarify some exceptions when it comes to claiming property tax deductions. These exceptions currently allow deductions for improvements made:

  • by a proper taxing authority;
  • for general public welfare; and
  • at a comparable rate for all property owners in the jurisdiction.

The FTB will wait to make these clarifications final for California taxpayers until the IRS publishes further clarification for 2012 tax returns later this year.

Mello-Roos payments would not qualify under these exceptions, since these improvements benefit specific sections of the community, not the general public. Additionally, Mello Roos payments are not uniform for all property owners in an affected subdivision. Still, some property owners persist in their efforts to get around these limits.

More subsidy for wealthy constituents–can we have our loophole back?

Meanwhile, Assembly Bill (AB) 1552 is currently bouncing around the grounds of the state capital to create yet another homeownership subsidy. The bill, if enacted, would nullify the FTB’s ability to recognize impermissible deductions from property tax deductions. It would make all fees, assessments and Mello-Roos principal and interest payments reportable as property tax deductions based solely on their payment to the tax collector.

What is abhorred about AB 1552 is the money, and the logic, behind this bill. Of the 13 Assembly members and senators who coauthored this bill, 11 received campaign contributions from CAR. The others likely will. These combined contributions totaled over $500,000, according to the National Institute on Money in State Politics. While CAR makes no public claim to sponsoring AB 1552 at this time, they have contributed significant amounts to support prior bills to keep local property taxes low, or decrease them further. Since 2004, CAR has paid out more than $9.7 million to support candidates and bills. A great investment, if the momentum enacts the bill barring $200 million homeowner dollars from getting into local government coffers.

Related article:

2012 Legislative Gossip

Mello-Roos payments are not taxes, they are principal (and interest) repaid on debt incurred by a developer to construct offsite improvements benefiting homes on a parcel of land.

The effect on local communities

As loans (bonds) made by investors and secured by all the homes involved, they are not property taxes by any sort of classification, nor are they to be claimed as tax deductible. The idea homeowners should receive income tax deductions for principal payments on installment debt encumbering their property,which would be foreclosed (similar to a trust deed mortgage) if not paid to the tax collector is yet another subsidy to promote homeownership over renting.

While homeowners should certainly claim all tax deductions they are entitled to, a healthy state budget is made possible by its citizens paying taxes.Otherwise, our institutions allow social Darwinism to set in at all levels of human activity – not good for our state’s economy. If legislators (who mainly represent wealthy and gated constituents unbothered by reliance on the community services made possible with property taxes) push this tax bill through it will make still another tax break on the slippery home-subsidy slope.

California real estate (especially of the single family residence variety) does not need subsidies to create demand. Families who want to own a home will do so as they have in the past and will continue to do so, without any agent past or present ever giving them advice on acquisition about tax aspects of ownership (no form is in use for calculating homeowner tax disclosures by a buyer’s agent).

Increased home subsidy deductions mean a reduced state budget, which in turn means less employment, deferred infrastructure improvements and inadequate public services, and ironically, fewer home sales and lower prices —particularly in un-gated subdivisions. All the while California’s population grows 1% annually – requiring equal percentage growth in government services. You know: police/prisons, fire, safety, schools/universities, hospitals, infrastructure/public works, planning, building – departments too numerous to mention but all needed for a society to function in a capitalistic economy.

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Golden state population trends

Many readers will have heard about Los Angeles’ current budget woes – currently at a $222 million gap. One of the proposals to breathe life back into the budget is to double the documentary transfer tax required for property sales (currently at $5.60 per $1,000). When people get around paying taxes, local budgets fail and they make it up by raising taxes in other areas or reducing the quality of services rendered, an unacceptable alternative for maintaining property values.

As with families and companies, the stronger the financial state of local government, the more footholds we have for climbing out of this economic stagnation.“We” are a team in this respect.

Thus, the increased tax revenue resulting from limiting property tax deductions to — well, property taxes— would help the state regain some financial stability. The increased revenue would be spent, the resulting improvements to infrastructure and maintenance will create jobs and in turn, the employed buy homes and rent apartments, the end game in the world of real estate.

Related market charts:

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Jobs move real estate

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