Under the TCJA, taxpayers’ itemized deduction for state and local taxes for tax years 2018 through 2025 is limited to $10,000 ($5,000 for married filing separately) per year. Anticipating some clever tax planning by taxpayers and their advisors, the new law specifically indicated that taxpayers could not deduct prepaid 2018 state income taxes on their 2017 federal income tax return.
However, the new law said absolutely nothing about the prepayment of state property taxes. As a result, many taxpayers who were residents in states with high property taxes rushed to prepay their property taxes by December 31, 2017, so those payments could be deducted on their 2017 federal income tax returns, where the $10,000 cap did not yet apply.
On December 27, 2017, the IRS issued an advisory that placed restrictions on the prepayment of property taxes, indicating that prepayments of 2018 property taxes in 2017 would be deductible in 2017 only if the property taxes were assessed in 2017.
In response to this new $10,000 limitation, former New Jersey Governor Chris Christie issued an Executive Order, also on December 27, 2017, that required municipalities to accept payments for 2018 property taxes in 2017. Then, on April 20, 2018, current New Jersey Governor Phil Murphy signed a law that retroactively enacted Governor Christie’s property tax prepayment Executive Order. The New Jersey Attorney General asked the IRS to confirm that such prepayments would be deductible in 2017. In response, in July the IRS issued a response that reiterated its position that prepaid 2018 real property taxes may be deductible on 2017 returns only if (1) the taxes were assessed prior to 2018 and (2) the taxpayer made the payment in 2017.
Specifically, the IRS noted that if the tax wasn't imposed by a state or local tax jurisdiction by the end of 2017, the payment wouldn't be deductible in 2017. This is not a new IRS position; it predated the TCJA and has been upheld by the courts. State or local law determines whether and when a property tax is assessed (i.e., when the taxpayer becomes liable for the property tax imposed).
Treasury Secretary Mnuchin warned that the IRS will be auditing this real estate tax prepayment issue. Therefore, taxpayers in all states who have not yet filed their 2017 federal income tax returns and who prepaid their 2018 property taxes in 2017 will need to confirm that those taxes were in fact assessed by their respective municipality prior to 2018 before claiming the deduction on their return. Taxpayers who have already filed their 2017 tax returns and inappropriately deducted 2018 property taxes that had not been assessed prior to 2018 should consider filing amended income tax returns.