Tax Planning

Prepaying your property tax? IRS cautions it might not pay off

Ben Casselman
What you should know before prepaying your property taxes under new tax code
What you should know before prepaying your property taxes under new tax code

The Internal Revenue Service has a message for the homeowners rushing to prepay their property taxes before new rules take effect on New Year's Day: Not so fast.

The tax bill that President Trump signed into law last week sharply limited the itemized deductions for state and local taxes while raising the standard deduction for individuals and couples. Those rules do not take effect until 2018, however. That has led some homeowners, particularly in high-tax, affluent areas, to try to prepay their 2018 property taxes before the deduction disappears.

In an advisory notice posted to its website on Wednesday, the I.R.S. said that maneuver could work, but only under limited circumstances. To qualify for the deduction, property taxes not only need to be paid in 2017, they must also be assessed in 2017 — meaning that homeowners who prepaid their taxes based on estimated assessments, or who tried to pay several years' worth of taxes at once, will probably be out of luck.

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"Those individuals now are not getting the benefits of those prepayments," Nicole Kaeding, an economist at the Tax Foundation, said of people who paid taxes that had not yet been assessed. "All that you've done is provided an interest-free loan to your municipal government."

Taxpayers scramble to prepay property taxes
Taxpayers scramble to prepay property taxes

It is not clear how many people have tried to prepay their taxes. In Fairfax, Va., hundreds of people lined up to prepay taxes on Tuesday, according to local media reports, and communities in New York, New Jersey and other states have likewise reported a rush of prepayments.

Some states have encouraged residents to try to skirt the new cap on state and local tax deductions. Last week, Gov. Andrew M. Cuomo of New York signed an executive order paving the way for residents to prepay their property taxes.

"We're doing this to circumvent the bill the president just signed?" Mr. Cuomo asked at a Friday news conference. "You're damn right I am."

Those efforts could still succeed. The I.R.S. guidance is advice to taxpayers and tax preparers, not a legal ruling. And the agency did not define what it means for a tax to be "assessed."

That could turn out to be a key question. Property tax schedules vary widely from state to state and even county to county. Some states have already sent out tax assessments for part of 2018, even if the payments are not due until next year. In those states, tax lawyers said, homeowners who prepay taxes will almost certainly be able to deduct their taxes under the 2017 rules.

Other states have not even begun the 2018 assessment process. In those states, prepayment almost certainly will not help taxpayers.

And in some states, homeowners may have received estimated assessments or taxes due in 2018 based partly on assessments from earlier years. Similarly, Mr. Cuomo's executive order allowed local governments to levy taxes ahead of schedule. How the I.R.S. will treat such cases remains uncertain.

"It's an open question right now," said David Herzig, a professor of tax law at Valparaiso University. "It depends on your state. There's going to be no uniform answer."

Mr. Herzig said the I.R.S. guidance was also based on limited precedents and could be overturned by a legal challenge. As a result, he said, many taxpayers might prepay and hope that the courts rule in their favor.

That could be a risky strategy for some taxpayers, however. Andy Grewal, a professor of tax law at the University of Iowa, said that homeowners who paid their taxes into an escrow account — a common practice — could end up facing an audit if they prepay, because the tax payments they report to the I.R.S. will differ from those reported by their banks.

"I think people should be aware that there could be some administrative headaches that come out of this," Mr. Grewal said.