Real estate can be a reliable way of building up intergenerational wealth to leave to your heirs. However, owning real estate also means that you will have to pay property tax levied by state and local governments. This can cut into the gains and benefits of your real estate investment. On the other hand, you may be able to minimize the unfavorable consequences of property taxes by writing them off when you file your federal income taxes.
Which taxes can you deduct?
Tax law allows you to deduct from your federal taxes any taxes on property paid to local, state, or foreign governments that are collected for the general benefit of the public welfare. However, you will not be allowed to deduct taxes paid on real estate that you do not utilize for personal uses. Additionally, payments made to pay taxes on home renovation cannot be deducted from federal taxes. Also, you cannot deduct for other routine services such as trash collection.
Rental and commercial real estate
Since only property utilized for personal purposes can have property tax deductions, you are not allowed to deduct property taxes paid on rental and commercial properties. Keep this in mind if you are trying to decide whether or not to invest in a commercial or rental property. You may want to consult a wealth management advisor to make sure to incorporate this into your family financial planning vision.
Closing costs and taxes
It is common to overlook the costs that arise when you close a real estate deal. Usually, the city or county government will levy these taxes based upon the value of the property. These closing costs include various expenses such as deed recording fees, loan origination charges, credit report fees, a variety of taxes, title searches and title insurance.
Usually, you will see closing costs and taxes between 2% and 5% of the real estate’s assessed value. However, you are allowed to deduct these taxes and charges from your federal income tax bill.
Delinquent tax bills
Often during a real estate transaction, the buyer will agree to pay for the seller’s unpaid property taxes that are delinquent. However, you are not able to deduct these tax payments because they are categorized as part of the cost of purchasing the real estate.
Tax Cuts and Jobs Act
You should know that the rules for deducting property tax payments from your federal tax returns is always subject to change based on how lawmakers vote on applicable legislation. Lawmakers decided in 2017 to reduce how much you are allowed to deduct by passing the Tax Cuts and Jobs Act (TCJA) which became effective in 2018.
TCJA limited deductions on all local and state taxes, which includes property taxes. Under this law the limit on how much of these taxes you are allowed to deduct is capped at $10,000 for an unmarried person and $5,000 per married individual that files tax returns separate from their spouse.
Keep an eye out for changes in the rules
Make sure to pay close attention to any potential changes to the laws regarding how much property tax you are allowed to deduct from your federal tax returns. When these changes do occur, you will want to be ready to adapt your financial plans if necessary.
The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Opinions expressed in the attached article are those of the author and are not necessarily those of Raymond James. This material is being provided for information purposes only. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.