California should be OK as IRS blocks some property-tax deductions

As taxpayers across the nation race to pay their property taxes early, assuming they're getting one last shot at a federal deduction set to be scaled back under the new tax rules, confusion has set in over who exactly will benefit from this early-bird strategy.

Causing even more head-scratching, the Internal Revenue Service weighed in on the matter late Wednesday, announcing that these early payments will be deductible only in certain situations. This sent off flares in East Coast states where folks were doing some things the IRS didn't like; The Washington Post reported that the IRS ruling could invalidate many taxpayers' prepayments and put pressure on local governments to refund millions of dollars collected from misguided taxpayers.

But if you're a taxpayer in the Golden State, don't panic. Our best guess is that Californians who are planning to pay - or already have paid - the tax bill sitting on their desk will get their deductions. With the help of reports in the Post, The Hill and other news outlets, and input from Santa Clara County assessor Larry Stone, here's what you should know.

In one of the more controversial elements of the tax law, there'll be a new $10,000 annual cap on deductions for state and local taxes. The rule will disproportionately affect higher-tax and traditionally Democratic states like California and New Jersey, and the limit on property-tax deductions will hurt millions of homeowners in pricey housing markets like the San Francisco Bay Area.

In states like New York and California, with high property values resulting in high property taxes, tax collectors have been bombarded by people trying to pay their property taxes early to get a deduction in 2017 that they may not get in 2018.

The IRS on Wednesday cautioned taxpayers that prepayment of state or local real property taxes may not be deductible if those property taxes haven't been assessed yet.

“A prepayment of anticipated real property taxes that have not been assessed prior to 2018 are not deductible in 2017,” the statement says.

There are two different things happening here. Let's look at California first.

As Stone notes, property assessments are done each year based on values as of Jan. 1.

“My office closes the assessment roll for Santa Clara County on July 1. And just like every other county in the state, the tax is 1 percent of the assessed value. The bills go out in October and you can pay it in two installments.”

The first is due Nov. 1 and delinquent on Dec. 10, and the second installment is due on Feb. 1 and delinquent on April 10.

In normal circumstances, most of us delay paying that second installment until close to the April deadline for delinquent payments. But this year, faced with changing tax laws, a lot of us - on the advice of our accountants and listening to local assessors like Stone - are paying the second installment in December.

According to the Washington Post, in some East Coast states, taxpayers have been even more aggressive. Rather than simply paying their 2017-2018 taxes before they're due, they've been obtaining estimates of their 2018-2019 taxes and paying those as well. This has been encouraged by accountants and some government officials. Now, the IRS is saying “no dice.”

Based on the examples in the IRS advisory, it should be. To use the IRS' own words, if you pay the second installment of the tax bill sitting on your desk, you are not making “a prepayment of anticipated real property taxes that have not been assessed.” You have been assessed for 2017. You've got the bill.

Or in IRS bureaucratese: “Assuming taxpayer has paid the first installment in 2017, the taxpayer may choose to pay the second installment on Dec. 31, 2017, and may claim a deduction for this prepayment on the taxpayer's 2017 return.”

What you don't have yet is a 2018 bill. And you can't get ahead of the game by guessing what that 2018 bill is going to be, and paying it as well. Says Stone: “you can't pay any of your 2018 property taxes in California right now because you can't pay a tax that hasn't yet been levied. And your property-tax bill for 2018 is based on the assessment roll which will close July 1, 2018.”

Unfortunately, no. The IRS won't disallow the payment (or at least, that's the best guess), but Stone says other factors come into play in determining a sage tax strategy. He recommends taxpayers talk to their accountant for advice. As he points out, if you don't itemize your deductions when you pay your taxes, then paying that second installment early becomes a moot point.

“If you itemize your taxes and if you think you'll itemize them next year, then you should pay that second installment,” he says. “If not, then there's no reason to pay that second installment early because if you don't itemize it wouldn't make any difference in the taxes you pay.”

To further complicate things, Stone adds that some people who itemized in the past may not do so under the new tax scheme because the law “roughly doubled the the standard deduction.”

Generally, however, Stone says that paying off the second installment now can't hurt and might help.

“If you don't have time to talk to your tax professional, I would pay it because at the very least you're only out of that money for four months. If your bill is $5,000, each installment would be $2,500. So if you pay if all off before Dec. 31, you could deduct the full $5,000 instead of just half of it.”

The governor of New York took emergency executive action to allow state residents to prepay their property taxes. And in New Jersey, the governor ordered local governments to accept prepayment of property taxes. It appears the IRS advisory will thwart those strategies, because those states were encouraging early payment of 2018 taxes, not simply getting your 2017 taxes paid before the end of the year.

Declares the IRS: “Taxpayers who prepay their 2018-2019 property taxes in 2017 will not be allowed to deduct the prepayment on their federal tax returns because the county will not assess the property tax for the 2018-2019 tax year until July 1, 2018.”

No one in California - at least that we've heard of - has been suggesting that you could deduct your 2018 taxes in 2017. Here, it's all about paying the 2017 taxes before they're due.