Deidre Woollard: Nobody likes paying taxes, especially if you live in a high-tax area
of the United States.
While Uncle Sam does like to get his cut, one silver lining is that you potentially
can get a nice tax deduction for the real estate property taxes you pay.
Hello, my name is Deidre Woollard, editor of Millionacres.
On today's FAQ, we're looking at real estate tax deductions and what you can and can't
deduct on your taxes when it comes to your property and real estate investments.
We will cover what you need to know about the current state of the real estate tax deduction,
and how to determine whether you can use it or not. First, the good news.
Real estate taxes are still deductible on your tax return.
This includes taxes that you pay for ownership of your primary residence, vacation home,
and undeveloped land.
It doesn't include property taxes on any investment properties you own, although that's generally
deductible in another way, which we'll get into later on.
Before we get started, one important point is that real estate taxes are deductible in
the year they're paid, not in the year when they are assessed.
If you get your 2019 real estate property tax bill in October, and don't pay it until
January 2020, any real estate tax deduction would occur on your 2020 tax return, even
though the taxes were billed in 2019.
Also, keep this in mind if you pay your taxes in two or more installments: your taxes are
paid when the money's actually sent to your local government, not in the tax year when
you paid the money into your escrow account as part of your mortgage payment.
Here's the first thing you need to know about real estate tax deductions.
To deduct real estate taxes, or any other type of personal property taxes, you need
to itemize deductions on your tax return.
When you fill out your tax return, you have two main choices when it comes to deductions.
You can itemize deductions, which means you list each deduction which you are entitled
to and subtract them from your taxable income.
Or, you can choose to take the standard deduction and use it to lower your taxable income instead.
You can use whichever is most beneficial to you.
What this means is, if your itemizable deductions are more than the standard deduction, it's
worth itemizing. If not, you're better off with the standard deduction.
The Tax Cuts and Jobs Act dramatically increased the standard deduction, so itemizing isn't
worthwhile for most Americans.
Here's a quick way to estimate if you'll be able to itemize.
First, add up any of these common itemized deductions you're entitled to:
• mortgage interest on as much as $750,000 in principal;
• medical expenses that exceed 10% of your adjusted gross income;
• charitable contributions; • state and local income and property taxes
up to $10,000. This includes your real estate taxes.
More on this in the next section.
Then, compare the total to your applicable standard deduction.
Here are the standard deductions for the various tax filing statuses in 2019.
That's the federal income tax return you'll file in 2020.
I mentioned in the previous section that state and local property taxes are deductible,
only to a maximum of $10,000. Let's expand on that.
The deduction for state and local taxes, also known as the SALT deduction, is one of the
most popular itemizable deductions on U.S. tax returns.
In fact, before the passage of the Tax Cuts and Jobs Act, it was the most widely used
deduction by Americans in terms of dollar value.
In a nutshell, the SALT deduction includes the following:
• state and local property taxes, including real estate taxes and taxes assessed on other
personal property, such as automobiles; • state and local income taxes;
• state and local sales taxes.
The major change made by the new tax law is that the entire deduction is capped at $10,000
per return, $5,000 for married filing separately.
In other words, if you paid $6,000 in property taxes and $8,000 in state income taxes for 2019,
your SALT deduction is $10,000, not the $14,000 you actually paid for those expenses.
Here are two quick examples of how the real estate tax deduction works in the real world.
First, let's say that you're married and that your joint taxable income before deductions
is $100,000 for 2019.
Imagine that you paid $7,000 in mortgage interest, donated $2,000 to charity, paid $7,000 in
state income taxes, and paid $6,000 in real estate taxes.
Because the SALT deduction is limited to $10,000, your total itemizable deduction would be $19,000.
You would be able to deduct the $7,000 in mortgage interest, the $2,000 from your charitable donations,
and then just $10,000, not $13,000, for your state income and real estate taxes.
Since your standard deduction is $24,400, itemizing wouldn't be worthwhile for you,
and you wouldn't deduct your real estate taxes for 2019.
Now, let's do another example with the same base assumptions -- you're married with $100,000
of taxable income, but this time, you paid $11,000 in mortgage interest, gave $4,000
to charity, paid $5,000 in deductible medical expenses, paid $7,000 in state income taxes,
and paid $6,000 in real estate taxes. This would give you a total of $30,000 in itemizable deductions.
You would be able to deduct $11,000 in mortgage interest, the $4,000 you gave to charity,
the $5,000 you paid in deductible medical expenses, and then $10,000, again, not $13,000,
for the combination of the state income taxes and state real estate taxes you paid.
Since this exceeds your standard deduction, it would make sense for you to itemize.
If you own any investment properties and pay taxes on them, the real estate tax deduction
works a little differently.
Instead of deducting it on your tax return as an itemized deduction, you can use the
property taxes you paid to offset the rental income your property generates, just like
any other operating expense.
For example, let's say you have a rental property that generates $1,000 per month in rent, so $12,000 per year.
You pay $3,000 in real estate sales tax, $5,000 in mortgage interest, and $1,000 in other
operating costs.
You can subtract the $9,000 in expenses to bring your taxable rental income down to $3,000.
You can then use your depreciation deduction to reduce it even further.
This isn't subject to the $10,000 SALT limitation.
If you own a portfolio of rental properties, you can use all the real estate taxes you
pay for them to help reduce your taxable rental income.
The property tax deduction rules discussed here,
specifically the SALT limit and the standard deductions amounts, were results of the
Tax Cut and Jobs Act, which passed in late 2017 and went into effect for the 2018 tax year.
Like most other provisions of this legislation that affect individual taxpayers, these rules
are currently scheduled to disappear after the 2025 tax year.
This means that unless Congress decides to extend the changes, the $10,000 SALT deduction
limit will go away, and the standard deduction would be roughly cut in half beginning with
the 2026 tax year.
Additionally, depending on the outcome of the 2020 election, the SALT deduction could
be modified sooner.
Remember, tax laws change over time, and legislation became an especially fluid concept
over the past few years, so the rules could be different in the future.
We will cover any upcoming changes on the Millionacres website.
If you need more information on real estate taxes, please visit our taxes hub on millionacres.com.
You can find the link for that down in the video description.
If you want more info on real estate investing, get our free guide at real.fool.com.
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