Hat tip to ProfHoff for sending in this update from sfgate.com:

Many California homeowners may be surprised to learn that some charges on their property tax bills are not deductible on their income tax return.

The Franchise Tax Board is on a mission to get California homeowners to follow the law and stop deducting the entire amount of their property tax payment. Increasing compliance would raise money for the state and federal government.

(Reminder: California homeowners must pay the first half of their 2011-12 property tax payment by Dec. 10 to avoid penalties.)

Tax pros say the vast majority of homeowners deduct their entire property tax payment as an itemized deduction on their federal tax return, even though federal law prohibits deducting certain taxes and fees. Taking the full deduction reduces state as well as federal taxes.

To be deductible, a property tax must be a percentage of the home’s assessed value (known as an ad valorem tax). It also must be imposed uniformly throughout the community and benefit the general community or government.

Any tax that is a flat fee per household or an itemized charge for services assessed against specific property or certain people is not deductible. Nondeductible charges might be identified as Mello-Roos or Community Facilities Districts, 1915 assessment district bonds, lighting and landscape, parcel taxes, school or college measures and bonds, water, sewer, flood, police, fire and libraries, the tax board says on its website.

Property tax bills do not break out which charges are and are not deductible. In many cases, it’s hard to even decipher what the charges are.

Nevertheless, the tax board told tax preparers in September that it was going to add three lines to 2011 California income tax returns asking homeowners for their parcel number, the amount of property taxes paid and the nondeductible amount.

After getting many complaints from the tax community, the board decided in mid-November to postpone these changes until 2012 tax returns and in the meantime try to educate homeowners about the issue.

Nothing in writing

“Our concern was that it’s very difficult sometimes to tell what is and is not deductible,” says Lynn Freer, president of Spidell Publishing, a tax information service. “They did this without really getting information from the IRS, in writing, as to whether or not Mello-Roos taxes are deductible. They generally probably are not, but sometimes they may be. There was never a written ruling on that.”

Mello-Roos taxes finance schools and infrastructure improvements in many communities in the state. They can add thousands of dollars to property tax bills.

In its instructions for Schedule A, Itemized Deductions, the IRS tries to explain which real estate taxes are and are not deductible. The IRS has not been cracking down on this issue because it mainly affects California taxpayers.

In most states, property tax bills are fairly straightforward and mostly deductible. That’s because most states can increase property tax revenue by raising the rate or reassessing properties on a regular basis. This results in higher ad valorem taxes, which are usually deductible.

But Proposition 13 strictly limits increases in general property tax revenue in California. Communities that want to raise revenue must pass parcel or other types of taxes that are often nondeductible.

Potential revenue

The IRS “is licking its chops” over the potential federal revenue the state tax board’s move could generate, Freer says. “Whatever you owe the state, you will owe about three times that amount to the IRS.”

She adds that this is not an issue for people who are subject to alternative minimum tax because they don’t get the benefit of property tax deductions.

The tax board will launch an educational campaign in January and hope more taxpayers will comply voluntarily with the rules. It has posted guidance for taxpayers at sfg.ly/rHNwOA.

Some counties have posted sample tax bills on this Web page that identify some charges that are and are not deductible, but the samples do not show all charge on a homeowner’s property tax bill.

Some years ago, the Department of Motor Vehicles began showing drivers on their registration renewal notices which part of their bill – the vehicle license fee – is tax deductible. “The (fee) is tax-deductible since it is based on your car’s value,” says Richard Pon, a San Francisco CPA. The DMV also has a Web page where taxpayers can look this up at sfg.ly/s9BkBX.

Nobody likes paying more taxes, but if the tax board wants to increase compliance, it should persuade county tax collectors to do something similar.

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