ALBUQUERQUE, N.M. — Q: I am a CPA and we have had an issue arise this tax season that I’d like your take on. If a client has an investment property that is not being rented, such as undeveloped land, are the property taxes subject to the $10,000 overall limit on tax deductions? For our clients with income-producing property we put everything, including property taxes, on Schedule E and the taxes do not become subject to the limit. But the property tax deduction for undeveloped land is shown on Schedule A, which seems to make it part of the $10,000 limit. Several people in our office think this is the right answer, but I think property taxes on investment property should not be limited. Do you know what the correct answer is and how to prove it?
A: If you read my column, even occasionally, you know that I do not like the new tax law. This is apart from any policy aspects of it; the law is just very poorly drafted and it was rushed through without considering how to minimize compliance problems.
This is one of them. The problem is that many, if not most, people will get this one wrong. The property tax paid on undeveloped land that is held for investment (not held for future personal use such as construction of a personal residence) is deductible without limit (if you itemize).
That is the correct answer — the taxes are not part of the $10,000 limit. That answer should be easy to find and to prove. Unfortunately, it is not.
Most taxpayers would first look to the instructions for an IRS form. As you note, without the production of rental income you would not file a Schedule E for undeveloped land. So the taxes would be deducted on Schedule A.
The 2018 Schedule A has a Line 5 to report tax payments. Line 5a is income or general sales taxes. Line 5b is real property taxes. Line 5c is personal property taxes. Line 5d is the sum of the first three lines, and Line 5e limits the total to $10,000.
So anything on Line 5 is limited to $10,000 in total. Line 6 is “other taxes” and is not limited. You must provide your own list of each tax reported on Line 6.
Returning to the IRS instructions for guidance is a problem. The instructions for Line 5b (property taxes) say to list all real property taxes for property that “wasn’t used for business.”
I have previously written that a single rental property can qualify as a business based on a long line of Tax Court precedent. But undeveloped land, with no income, cannot be a business.
IRS instructions would then have you report the property taxes on the undeveloped land on Line 5b. The taxes would then become part of the overall $10,000 limit on tax deductions. But this is not right.
To see what is right we need to look to the law, not to IRS instructions. If the IRS does a good job writing instructions you can think of them like three of a kind in poker. But the law is a royal flush. The law always trumps an IRS instruction.
Section 164 is the law. Section 164(b)(6)(B) limits the total of four types of tax deductions to $10,000 per year. The four are — personal property taxes, state and local taxes (including income and property), foreign taxes, and general sales tax.
But the “flush language” of the statute says to exclude real and personal property taxes paid for business or investment property from the $10,000 limit. Investment property is more specifically called Section 212 property.
Section 212 deals with property “held for the production of income.” Regulation Section 1.212-1(b) makes clear that holding for the production of income includes property that will realize income only when sold, even if there is no current income.
So undeveloped land held for investment is Section 212 property. This means that the property taxes on that land are not limited by the $10,000 overall “Line 5” limit. The trick is how to show the taxes. I would place them on Line 6 (“other taxes”) with a description. This avoids the limit.
Jim Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at email@example.com.