Real Estate Tax

In a nutshell, a taxpayer with title to a property is allowed an itemized deduction for the amount of local, state, or foreign real estate tax he pays if (1) the tax is based on the property’s assessed value and (2) the property against which this tax is levied is not used in a trade or business or held for the production of income. However, no deduction is allowed for a if it is in substance a local benefit tax, that is to say, a tax for a local benefit or improvement that tends to increase the value of a taxpayer’s property. More generally, the Internal Revenue Service, in its effort to determine the true nature of a , may disregard the actual or “advertised” form of the tax in question and look instead to the substance of the transaction. Only if the tax is a uniform assessment on real property throughout the relevant political subdivision–in short, a levy made for the general public welfare–will it be deductible as an itemized deduction on Schedule A of Form 1040 (see the Tax Forms page on the navigation menu above for a copy of Schedule A).

In more precise terms, local real estate tax is a tax levied against the ownership of real estate by a city, county, municipality or like political subdivision (borough, township, village, etc.); in a similar but more spacious way, state real estate tax is a tax imposed on owners of real estate by a state or commonwealth of the United States, the District of Columbia, or a possession of the U.S. or any political subdivision thereof. And foreign real estate tax is a charge on real estate ownership by the authority of a foreign sovereign state or any of its political subdivisions. As with , real estate tax is deductible in the year paid or accrued.

Matters are more complicated, however, as real estate tax is a term of art, namely, shorthand for the fact that, in addition to restrictions based on ownership and assessed value, this tax is deductible only if it is levied for the welfare of the general public. In other words, any that is in substance a tax for a local benefit or improvement to a taxpayer’s real estate in the form of, say, a sidewalk or street or a sewer, water, or solid waste disposal system is not deductible unless, and to the extent, it can be shown to be allocable to the maintenance and repair of, or interest charges on, the local benefit or improvement in question. For example, a charge, and any cost of borrowing or interest expense included in such charge, made for the purpose of maintaining a street or repairing a sidewalk would be deductible as a real estate tax. However, an itemized charge for a service made possible by a local benefit or improvement–for instance, a charge for water consumed, trash collected, or sewage disposed–is not deductible as a real estate tax.

In a larger sense, an assessment or charge the end result of which is an improvement that tends to increase the value of a taxpayer’s real property–one example being a conversion of a dirt road to a paved street–is not deductible; instead, the increase in value that results from such improvement must be added to the property’s basis.

What follows below is a laundry list of issues to consider as one works through the complex topic of real estate tax:

Additional relevant articles on the topic of real estate tax are listed below:

Many happy returns, Roger

State Tax

As a rule, the amount an individual pays for taxes that are not directly related to a trade or business or property held for the production of income is deductible only as an itemized deduction on Schedule A of Form 1040; this category of expense includes , specifically and . A taxpayer has the option to deduct either state and local sales taxes or state and local income taxes, but not both categories of .

If a taxpayer elects to itemize, then the payment of general state and local sales tax is deductible only if the following conditions are satisfied (”general” denotes that the sales tax is imposed at one rate for the retail sale of a broad range of personal property):

  1. The sales tax is imposed on personal property.
  2. The sales tax is based on the property’s value, that is, it has the quality of an ad valorem tax and is assessed in proportion to the value of the property.
  3. The sales tax is imposed annually.

If a payment for a car registration, a licensing fee, or other motor vehicle tax is based on the value of the vehicle, it is deductible for those who itemize on Schedule A.

Example: Rob Becker paid $150 to register his car in 2007; $100 of the fee is based on the value of the car and $50 on the weight of the car. Becker’s deduction is limited to $100, the amount of the registration fee that is assessed in proportion to the value of the car.

The taxpayer who elects to deduct state taxes can claim either (1) the total amount paid if it is properly substantiated, that is, supported by receipts or other appropriate documentation or (2) the amount from an Internal Revenue Service table plus any amount of state and local sales tax paid on the purchase of a motor vehicle, boat, home (including those that are mobile or prefabricated), or materials to build a home. If a taxpayer residing in more than one state during the year elects to use the IRS tables, then she must, on the basis of the number of days she lives in each state, prorate the applicable table amounts.

The deduction for sales taxes paid is, unfortunately, caught in the web of the itemized deductions phaseout for high-income taxpayers. In particular, the amount of allowable itemized deductions is reduced for those taxpayers whose adjusted gross income (AGI) exceeds a certain threshold amount by the lesser of (1) 3% of the excess AGI over the threshold amount or (2) 80% of allowable deductions. The 2007 threshold amount is $156,400 AGI ($78,200 for those married and filing separately, abbreviated as MFS) and the 2008 threshold amount is $159,950 AGI ($79,975 for MFS). The phaseout itself is being phased out: in 2006 and 2007, the phaseout is reduced by one-third, and, in 2008 and 2009, it will be reduced by two-thirds. In 2010, the phase out of the itemized deductions phaseout will be complete.

As most individuals who file a Form 1040 are cash-basis taxpayers, state taxes are usually deductible when paid, not when accrued, even if the payment is applicable to a prior tax year, or, in the case of an estimated payment, applicable to a future tax year. However, in the event a taxpayer makes an advance payment of estimated state income taxes but cannot reasonably determine whether, on the date of payment, an additional amount is due, he may be able to deduct any additional amount paid in the following year.

Finally, many states have e-file programs; click on for more information.

Additional relevant articles on state tax follow below:

Many happy returns, Roger

Qualified Dividends

Qualified Dividend Income
The value of a dividend paid by a domestic corporation or a qualified foreign corporation to a taxpayer between January 1, 2003 and December 31, 2010 will be recognized by the Internal Revenue Service as qualified dividend income thereby making it eligible for a lower ; this is the reason such income is labeled qualified dividend income. Qualified dividend income is taxed in 2007 at a 5% rate for taxpayers in the 10% and 15% tax brackets and at a 15% rate for those in the 25%, 28%, 33%, and 35% . In 2008 through 2010, a 0% rate will apply to taxpayers in the 10% and 15% tax brackets; the rates for taxpayers in the 25%, 28%, 33%, and 35% tax brackets will remain at 2007 levels.

A domestic corporation is a corporation created or organized in the U.S. A qualified foreign corporation is a non-domestic corporation other than a passive foreign investment company that is domiciled in a U.S. possession or territory or eligible for the benefits, including an exchange of information program, of a comprehensive income tax treaty with the U.S. A dividend from a foreign corporation is also a qualified dividend if it is paid on stock or an anti-deferral regime (ADR), and the stock or ADR is traded on an established U.S. securities exchange.

Ordinary Dividend Income
In contrast, the value of a dividend paid by a nonqualified corporation–that is, any corporation not a domestic corporation or a qualified foreign corporation–is classified as ordinary dividend income and taxed at ordinary income rates. Dividend income is defined broadly as the value of any distribution of money or property to a shareholder that is paid out of a corporation’s current earnings and profits or those accumulated after February 28, 1913. If a dividend is paid in cash, the amount of dividend income is obviously the amount of cash distributed to a shareholder. Likewise, the amount of dividend income for a distribution of property–a dividend paid in a form other than cash–is the property’s fair market value. In the process of calculating taxable income from a dividend distribution, the category of property includes all stock–but not a stock dividend from the distributing corporation unless it is of a class different than that on which the dividend is declared–and any economic benefit, regardless of form, a corporation provides to a shareholder, including payments to reduce a shareholder’s debt.

Holding Period Requirements for Dividends Paid on Qualified Stock
The fact that dividends are paid by a domestic or a qualified foreign corporation is a necessary, but not sufficient, condition for favorable tax treatment; for dividends to count as , the taxpayer must also pass the tests–or avoid the traps–listed below.

  1. The common stock of a domestic or a qualified foreign corporation is held for at least 61 days in a 121-day period beginning 60 days before the stock’s ex-dividend date. The holding period requirement is cumulative, that is, the 61-day period doesn’t have to be consecutive. (Note: A stock goes ex-dividend on the first day after a dividend is declared; in the period of time a stock is ex-dividend, the dividend is paid to the seller, not the buyer, of the stock.) Importantly, a taxpayer doesn’t receive credit towards the minimum 61-day holding period for common stock any day her risk of loss is diminished. Specifically, the risk of loss in connection with the qualified stock a taxpayer holds is diminished any day she has, or is bound by, a call option, a put option, or an open short sale contract (viz., a short sale made but not closed) for substantially identical stock or securities. In addition, risk of loss is diminished not only if the taxpayer is a writer of a call or put option for essentially identical stock or securities but also on any day she holds a position in substantially similar or related property. (Note: In figuring the number of days in a stock’s , count the day of disposal but not the day of acquisition.)
  2. The preferred stock of a domestic or a qualified foreign corporation is held for at least 91 days in a 181-day period beginning 90 days before the stock’s ex-dividend date and the dividend is attributable to a period of more than 366 days. As with common stock, the holding period doesn’t have to be consecutive nor does the taxpayer receive credit towards the minimum 91-day holding period for preferred stock any day her risk of loss is diminished.
  3. Any portion of a dividend that is treated as investment income in order to justify a investment interest deduction is not a qualified dividend.
  4. Dividends from a tax-exempt organization or a farmers cooperative are not eligible for qualified dividend income treatment.
  5. Any payments in lieu of dividends made by the taxpayer, as a short-seller, to compensate the lender of the otherwise qualified stock in a short sale transaction do not count as qualified dividends.

A dividend paid to a taxpayer by means of a pass-through entity such as a mutual fund or other regulated investment company, real estate investment trust, partnership, or a common trust fund is also eligible for the favorable capital gains rate if the distribution would otherwise be classified as qualified dividend income.

The reduced capital gains tax rate a taxpayer enjoys for qualified dividend income does not apply to dividend distributions from tax-deferred retirement vehicles such as deferred annuities, individual retirement accounts, 401(k) plans, and employer stock held on the date of record in an employee stock ownership plan that is maintained by the employer corporation. Moreover, the value of a dividend received from a building and loan association, credit union, mutual insurance company, mutual savings bank, or a nonprofit voluntary employee benefit association is not considered qualified dividend income and will be taxed at ordinary income rates.

Supplementary relevant articles on qualified dividends are listed below:

Many happy returns, Roger

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