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The Property Tax Deduction Problem

This post addresses the confusion caused by the Franchise Tax Board’s (“FTB”) decision to limit property tax deductions.  Despite having final discretion as to what is an acceptable deduction, the FTB provides little direction on which items on a property tax bill qualify for a deduction.

The FTB’s Position on Property Tax Deductions

The FTB’s new deduction limitations were introduced at the beginning of the 2012 tax year and will likely be strictly enforced.   Unfortunately, these deduction limitations create confusion as to which property tax items are actually deductible because no complete guidelines are set forth by the FTB.  This shifts the burden to the taxpayer to prove to the FTB that an item on their tax bill does in fact qualify as a deduction.

The FTB’s Website Offers No Helpful Guidance to Property Tax Deductions

The FTB’s website[1] provides little guidance to ascertain what is an acceptable property tax deduction.  Based on this website, it appears that the FTB does not know or keep track of the various line items on the property tax bill, let alone know which items or what portions thereof are deductible.

The website states that California law conforms to Federal law regarding real estate tax deductions.  Taxpayers may deduct only the amount of property tax paid during the year that is based on the assessed value of their property.  Property taxes paid for the local benefit that tend to increase the value of the taxpayer’s property are not deductible (the “Local Benefit Rule”).

The FTB provides an exception to the Local Benefit Rule and allows a deduction for taxes that are for the purpose of maintenance, repair, or interest charges related to local benefits such as sidewalks, streets, water lines, sewer lines, irrigation, and other similar improvement items.  In order to fall within this exception, a taxpayer bears the burden of convincing the FTB that it is applicable because an auditor will not have a list of allowable items which would create a bright-line standard.

To provide guidance to taxpayers seeking property tax deductions, the FTB gives a chart with several resources from which more information can be obtained. These resources include: (1) the websites for fifty-eight County Assessors’ offices; (2) the websites for fifty-eight County Tax Collectors’ offices; and (3) a county-by-county sample of a tax bill on which some local assessment phone numbers were provided.

This compilation of resources does little more than shift the burden to the taxpayer to navigate yet another website that is not guaranteed to have the information necessary to determine what property tax is deductible.  Also pursuant to the list of resources, the taxpayer may make a phone call to a local assessment district where a representative may or may not be able to provide answers.  This is hardly a satisfactory solution.

The FTB website states:  “Your county tax bill includes a contact number for the assessment district.  Contact your local assessment district if you need information regarding a special assessment.  Do not contact the county assessor for information on special assessments.”

A taxpayer who follows the FTB’s instructions and actually has a phone conversation with a local assessment district representative will not likely prevail upon audit without further supporting evidence.  The taxpayer lacks written proof or record of the phone call.  Taxpayers have the burden of proof with respect to property tax deductions and a confirming phone call with a local assessment district representative will likely fall short of adequate documentation.  Moreover, while the FTB website indicates that taxpayers should call their local assessment district, the foundation for this recommendation is questionable.  Many assessments do not include a contact number and the local assessment district advisors/managers are not equipped to determine which property taxes are deductible.  In fact, these advisors/managers may actually be instructed by legal counsel to avoid answering these questions.

With these considerations in mind, it appears that the fatal flaw in the FTB’s website is that it does not serve the purpose of helping taxpayers understand what is or is not deductible with respect to their property taxes.  It also gives taxpayers a false reliance on phone conversations with local assessment district representatives.

The Confusion Deepens as Applied to Business Real Estate

The confusion with respect to the FTB’s position on property tax deductions does not apply solely to personal residences.  The problem becomes even more complicated when dealing with real estate owned by a business.

Example:  A 12-Unit apartment building is assessed $136.00 annually for a school improvement bond.  The apartment owner must investigate whether/what portion of the $136.00 is nondeductible.

Possible Solutions

One option to provide more clarity is a legislative solution, requiring a formal written notice by each local assessment district that explains property tax bills and proper deductions.  Ideally, these notices would be organized in an online database that taxpayers could easily access to obtain guidance.  Another option would be for the legislature to intervene and spell out what taxes are deductible.

Impacts on Tax Preparers

Given the focus of the FTB on this issue, it is incumbent upon the tax return preparer to either instruct the client on how to research these issues, or independently review the tax bills in preparing the return.  Because most of these deductions would be relatively small, the only viable solution is for the tax return preparer to develop an explanation (including a reference to the FTB website) and include it within the taxpayer information request sheet.

The FTB’s Website

For those interested in reading the FTB’s guidance on property tax deductions, the website discussed in this article can be found at: https://www.ftb.ca.gov/individuals/Real_Estate_Tax_Deduction/index.shtml.

[1] https://www.ftb.ca.gov/individuals/Real_Estate_Tax_Deduction/index.shtml

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