When To Deduct Taxes

Generally, you can only deduct taxes in the year you pay them. This applies whether you use the cash method or an accrual method of accounting.

Under an accrual method, you can deduct a tax before you pay it if you meet the exception for recurring items discussed under Economic Performance in Publication 538. You can also choose to ratably accrue real estate taxes as discussed later under Real Estate Taxes.

Limit on accrual of taxes. A taxing jurisdiction can require the use of a date for accruing taxes that is earlier than the date it originally required. However, if you use an accrual method and can deduct the tax before you pay it, the accrual date for federal income tax purposes is the original accrual date. Use the original accrual date for all future years as well.

Example. Your state imposes a tax on intangible and tangible personal property used in a trade or business conducted in the state. This tax is assessed and becomes a lien as of July 1. In 2000, the state, by legislative action, changes the assessment and lien dates from July 1, 2001, to December 31, 2000, for property tax year 2001. Because December 31 is earlier than the original accrual date, the tax for federal income tax purposes accrues on July 1, 2001.

Uniform capitalization rules. Uniform capitalization rules apply to certain taxpayers who produce real or tangible personal property for use in a trade or business or for sale to customers. They also apply to taxpayers who acquire property for resale. Under these rules, you may have to either include in inventory costs or capitalize certain expenses related to the property, such as taxes. For more information, see Publication 551.

Carrying charges. Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. For more information, see chapter 8.

Refunds of taxes. If you receive a refund for any taxes you deducted in an earlier year, include the refund in income only to the extent the deduction reduced your tax in the earlier year. For more information, see Recovery of amount deducted in chapter 1.

You must include in income any interest you receive on state or local tax refunds.

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