The Tax Cuts and Jobs Act has now made it through the House of Representatives and the Senate. Very shortly it will be signed by the President and will become law – there may be items that affect you. Let’s discuss one of the major changes, the treatment of state and local taxes, as well as real estate taxes.
There has been much discussion over the last month as this legislation has progressed. Many news articles have talked about the benefit of paying your 2017 state and local income taxes before December 31, 2017, as well as prepaying real estate property taxes that are not due until 2018. These are valid tax minimization techniques, however, like many things that have been published, are subject to some limitations.
The final language of the bill amends Internal Revenue Code Section 164 by:
- Eliminating the deduction for foreign real estate property taxes
- Limiting the itemized deduction for the combined real property tax, state and local income tax and personal property tax to $10,000
- Making the prepayment of 2018 state and local income taxes a non-deductible expense for 2017
Another provision of the tax bill that is causing additional excitement is the raising of the standard deduction.
Most individuals are now looking at 2018 as a scenario where they will only deduct a fraction of their combined state and local taxes or not receive a benefit for them because their itemized deductions no longer exceed the standard deduction. This is leading them to want to capture these items in 2017. This strategy does work but has limitations.
The main limitation comes in the form of Alternative Minimum Tax (AMT), which is a parallel tax system that is calculated each year. An individual has the privilege of paying either regular income tax or AMT, whichever is higher. The problem is state and local taxes are not deductible for AMT purposes and therefore if an individual will be in AMT there is no reason to prepay these taxes in 2017.
Let’s break it down
For 2017, real estate and state and local taxes related to 2017 income that you pay now may result in a benefit on your 2017 return. If you are subject to AMT, it’s not necessary for you to prepay real estate or state and local taxes in 2017. For those who are not subject to AMT, if it makes economic sense and you have the funds available you may want to consider prepaying your 2017 state and local income taxes and your 2018 real estate taxes.
Look to Lurie for future updates on the upcoming changes on tax reform. If you have any questions or would like additional information on how this change could affect you or your business please contact your Lurie advisor.
Partner, Tax Services