People around the country are rushing to prepay their property taxes ahead of Jan. 1, when the tax overhaul enacted by Congress and signed into law by President Donald Trump takes effect. But who should prepay their taxes and how to do so is confusing for many taxpayers. 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.
Q: What are the basic issues involved?
A: On Dec. 22, President 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. Depending on how much money they make, that may shift them into a lower tax bracket. If they pay an effective 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 clever taxpayers might have a way to save a bit more when they file their tax returns this coming April (reflecting 2017 taxes). 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 their 2017 federal returns filed in April 2018.
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.
Q: Can I ignore this?
A: Yes! If you don't itemize your tax deduction (and most Americans don't), it will have no benefit for you, and if you pay less than $10,000 in state and local taxes, it won't have any benefit for you.
To figure out if you pay more than $10,000 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.
You can also ignore prepayment if you don't want to be bothered by it. As described below, there's no guarantee this will work, and there are some risks to prepayment. But if you do qualify, you might also be missing out on some savings.
Q: Who should do it?
A: 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.
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 4.5 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 Internal Revenue Service's AMT Assistant.
Q: So, how do I do this? What if I pay my property taxes through my mortgage lender?
A: First, it depends on whether your locality will allow it. Check with your local tax office.
Second, you'll need to figure out how much to pay. If your home's value increased or decreased a lot, that can be tricky. In many places, you can approximate a figure based on the latest assessment from your local tax office.
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.
Q: What are the risks?
A: The biggest is the IRS refuses to allow the additional deduction on your 2017 taxes. Most tax professionals seem to think the IRS will permit it, but the IRS has not issued formal guidance. An IRS spokeswoman didn't have an immediate comment.
So you can't be certain until and unless the IRS clarifies things. Even then, there's the possibility of legal cases or other legislative actions that thwart any effort to prepay.
Q: So what should I do?
A: Of course, it is up to you. If you do think you qualify, one way to think about it is risk and reward.
If you prepay your property taxes and the IRS accepts it, you might have saved a nice bit of money. 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.
On the other hand, let's say you prepay your property taxes and the IRS ultimately decides you can't deduct it. Then you've lost something. You've lost the value of having that money available to you for other purposes over the course of the year. One of those purposes might be an emergency cash fund, or it might be invested in stock, where returns have been pretty good the past few years.
Q: Anything else I should be aware of?
A: Prepaying property taxes might be just one way to adjust your personal financial situation before the end of the year.