Real Estate Taxes

Deductible real estate taxes are any state, local, or foreign taxes on real estate levied for the general public welfare. The taxing authority must base the taxes on the assessed value of the real estate and charge them uniformly against all property under its jurisdiction. Deductible real estate taxes generally do not include taxes charged for local benefits and improvements that increase the value of the property. See Taxes for local benefits, later.

If you use an accrual method, you generally cannot accrue real estate taxes until you pay them to the government authority. You can, however, choose to ratably accrue the taxes during the year. See Election to ratably accrue, later.

Taxes for local benefits. Generally, you cannot deduct taxes charged for local benefits and improvements that tend to increase the value of your property. These include assessments for streets, sidewalks, water mains, sewer lines, and public parking facilities. You should increase the basis of your property by the amount of the assessment.

You can deduct taxes for these local benefits only if the taxes are for maintenance, repairs, or interest charges related to those benefits. If part of the tax is for maintenance, repairs, or interest, you must be able to show how much of the tax is for these expenses to claim a deduction for that part of the tax.

Example. City X, to improve downtown commercial business, converted a downtown business area street into an enclosed pedestrian mall. The city assessed the full cost of construction, financed with 10-year bonds, against the affected properties. The city is paying the principal and interest with the annual payments made by the property owners.

The assessments for construction costs are not deductible as taxes or as business expenses, but are depreciable capital expenses. The part of the payments used to pay the interest charges on the bonds is deductible as taxes.

Charges for services. Water bills, sewerage, and other service charges assessed against your business property are not real estate taxes, but are deductible as business expenses.

Purchase or sale of real estate. If real estate is sold during the year, the real estate taxes must be divided between the buyer and the seller.

The buyer and seller must divide the real estate taxes according to the number of days in the real property tax year (the period to which the tax imposed relates) that each owned the property. Treat the seller as paying the taxes up to but not including the date of sale. Treat the buyer as paying the taxes beginning with the date of sale. For this purpose, disregard the accrual or lien dates under local law. You can usually find this information on the settlement statement you received at closing.

If you (the seller) cannot deduct taxes until they are paid because you use the cash method and the buyer of your property is personally liable for the tax, you are considered to have paid your part of the tax at the time of the sale. This lets you deduct the part of the tax up to the date of sale even though you did not pay it. You must also include the amount of that tax in the selling price of the property.

If you (the seller) use an accrual method and have not chosen to ratably accrue real estate taxes, you are considered to have accrued your part of the tax on the date you sell the property.

Example. Al Green, a calendar year accrual method taxpayer, owns real estate in X County. He has not chosen to ratably accrue property taxes. November 30 of each year is the assessment and lien date. He sold the property on June 30, 2000. Under his accounting method he would not be able to claim a deduction for the taxes because the sale occurred before November 30. He is treated as having accrued his part of the tax, 181/366  (January 1-June 29), on June 30 and he can deduct it for 2000.

Election to ratably accrue. If you use an accrual method, you can choose to accrue real estate tax related to a definite period ratably over that period.

Example. John Smith is a calendar year taxpayer who uses an accrual method. His real estate taxes for the real property tax year, July 1, 2000, to June 30, 2001, amount to $1,200. July 1 is the assessment and lien date.

If John chooses to ratably accrue the taxes, $600 will accrue in 2000 ($1,200 x 6/12, July 1-December 31) and the balance will accrue in 2001.

Separate elections. You can make an election for each separate trade or business and for nonbusiness activities if you account for them separately. Once you elect to ratably accrue real estate taxes, you must use that method unless you get permission from the IRS to revoke the election. See Revoking the election, later.

Making the election. If you make your election for the first year in which you incur real estate taxes, attach a statement to your income tax return for that year. The statement should show all the following items.

• The trades or businesses to which the election applies and the accounting method or methods used.
• The period to which the taxes relate.
• The computation of the real estate tax deduction for the first year of the election.

Generally, you must file your return by the due date (including extensions). However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Attach the election to the amended return and write "FILED PURSUANT TO SECTION 301.9100-2" on the election statement. File the amended return at the same address you filed the original return.

If you make the election for a year after the first year in which you incur real estate taxes, file Form 3115. Generally, you must file this form during the tax year for which the election is to be effective. For more information, see the instructions for Form 3115.

Revoking the election. To revoke an election to ratably accrue real estate taxes, file Form 3115 during the tax year for which the change is requested.

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