The new tax bill was officially signed into law this past Friday. Folks may have an opportunity to save thousands on their tax bills by prepaying 2018 property taxes before the clock runs out this year. Here’s who is affected.
Update (12/27/2017): The IRS released official guidance on prepayment of property taxes on December 27, 2017. See the official statement here.
The last week of the year is usually a quiet time in the Money Habit household for celebrating the holidays. This year, it’s looking to be a bit more hectic as we nail down some tax moves that could save us thousands of dollars if we tackle them before December 31st. One item that will benefit us and may also benefit you is the idea of prepaying 2018 property taxes now.
Depending on how large your property tax bill is and what your marginal tax rate is, getting your payment in today vs eight days from now could save you several thousand dollars.
What’s the Deal With Prepaying Property Taxes?
The tax bill that just passed is going to upend the way 2018 taxes are calculated. One major change is that state and local tax deductions on income and property tax will now be capped at $10k. In 2017, however, there is no such cap on the amount one can deduct for state and local income and property taxes. Because of this, it may behoove you to dump as many state and local tax payments into 2017 as possible so you save room in 2018 for the maximum $10k you can deduct.
Who Should Actually Do This?
Not everyone will benefit from this strategy. For example, if you don’t plan to itemize your deductions in 2017, you could care less about this strategy. The deductions for state income tax and property taxes require you to itemize your deductions rather than take the standard deduction. So let’s talk about the specific criteria that make you a good candidate for saving money with this strategy. There are two camps of folks who could really benefit:
The Homeowner Who Will Be Taking The Big Standard Deduction Next Year
- You plan to itemize your taxes in 2017
- Due to the higher standard deduction in the tax bill ($12k individual/$24k married in 2018 vs $6.35k individual/$12.7k in 2017), you plan to take the standard deduction in 2018
- You do not believe you will be subject to AMT tax in 2017
You have to itemize in 2017 to get a benefit if you prepay your property taxes. This is because property tax deductions are an itemized deduction. Because the standard deduction will be going up in 2018, many folks who used to itemize will now take the standard deduction. This may be you if you add up your usual itemized deductions and they add up to less than $12k as an individual or less than $24k as a married couple filing jointly.
The final criteria about AMT shows up because in the AMT calculation, you have to add back major deductions like state income taxes and property taxes and multiply them against the AMT tax rate. This lessens the effectiveness of the strategy though it may not negate it completely.
If this describes you, then anything you prepay on your property taxes for 2018 will add money into your pocket. You won’t be itemizing next year, so you won’t get to deduct your property tax payments next year and save on taxes. Do it this year and you will indeed get a deduction and a tax savings.
The Itemizing Homeowner Who Lives In a High Property Tax/High Income Tax State
- You will be itemizing your taxes in 2017
- You plan to itemize your taxes in 2018
- You believe your combined state and local income tax and property taxes will exceed $10,000 in 2018 OR that you will be subject to AMT in 2018 (I know this sounds like a strange pair of things to couple together, see below for explanation)
- You do not believe you will be subject to AMT tax in 2017
As I mentioned before, you need to itemize your taxes in order for any prepayment of property taxes to have an effect for you; this is because property taxes are an itemized deduction. So if you plan to take the standard deduction in 2017, this strategy is not for you.
Now say you are also planning to itemize your taxes in 2018 as you have in the past, and your total state and local income tax and property tax obligations will be over $10k. Well since there is a cap of $10k on deductions you can take for these deductions in 2018, anything you paid in excess of this you won’t get a deduction for in 2018. As 2017 doesn’t have that limit, you can make sure to get a deduction for your property taxes, which means in 2018 you get the whole $10k limit to apply to state income tax obligations.
Even if you don’t believe your state and local income and property taxes will exceed $10k in 2018, if you believe you will be hit by AMT in 2018, you still want to take advantage of this strategy. That is because, as mentioned above, with AMT you must add back major deductions like state income taxes and property taxes and multiply them against the AMT tax rate. That means you won’t get any benefit for these payments in 2018 whatsoever, but if you shifted them to 2017 you would see a benefit. Thus, if you meet the condition of either believing you will have these taxes exceed $10k in 2018 OR you believe you will be hit my AMT in 2018, you are a good candidate.
By the same logic above, you will see that our final criteria must be that you are not subject to AMT tax in 2017. Since AMT requires you to add back all state and local income and property tax payments, you must not be subject to AMT in order for prepaying anything to have an actual effect and send dollars back to your pocket in 2017.
2018 AMT Changes
For those who are trying to figure out if they will be hit by AMT in 2018: the amount exempted before calculating AMT has gone up significantly ($70.3k for individuals/$109.4k for married couples). The best I can calculate is that if you are planning to show less than $400k of taxable ordinary income as a married couple (that’s after you subtract out your tax-advantaged retirement account contributions), you will likely not be affected by AMT in 2018.
You can do a quick check for you individual situation by looking at your taxable income, subtracting your expected itemized deductions, and applying the balance against these brackets and then comparing it to your taxable income (adding back the usual AMT addbacks) subtracting out the exempted amount and multiplying that sum against the AMT tax brackets. I couldn’t find new AMT tax rates so my tentative assumption was that they are unchanged and thus roughly 28%.
Example: $400k Couple with $30k of deductions ($10k State and Local Income Tax Deductions, $20k mortgage interest)
- Under New Tax Brackets: The couple makes $400k and we subtract $30k of itemized deductions. We take the $370k figure and look up the tax obligation in the linked tables. Total: $81.8k in taxes
- Under AMT: We take $400k and subtract the exempt amount of $109.4k. Then we take the balance $290.6k and multiply against the AMT rate of 28%. Total: $81.4k in taxes
This couple is not subject to AMT taxes.
How Do I Go About Prepaying My Property Taxes?
The whole process was very quick and took me about 35 minutes. 20 minutes of that involved me traveling physically to the tax collector’s office with my check (you can shave this time off if you think mailing it will get it processed in time).
You should make two quick calls to get the ball rolling on this strategy. The first is to call the tax collection office in your city and determine whether they accept prepayments and whether they have . Some offices do and some don’t. For those that do, they will tell you which quarters in 2018 they have assessed amounts for. As of the IRS’s guidance December 27, 2017 (linked above and again here), these would be the only quarters for which prepayment will give you a sanctioned deduction.
If your call to the tax collector’s office is successful, your next call is to your mortgage loan servicer if you have a mortgage. Most mortgages are set up with the bank holding your property tax payments in an escrow, and the bank distributing these payments directly to the city. If you don’t have a mortgage or if your mortgage doesn’t escrow your property tax payments, you can skip this step. For those that do have an escrow, just give the customer service line a ring and ask if they’ll be able to adjust the escrow for 2018 if you prepay your property taxes. My mortgage sits with Citi and in two-minute call they confirmed that all I needed to do was submit proof of pre-payment and they would have the escrow re-calculated so I wouldn’t need to pay more dollars in for 2018 property taxes. Sweet.
All that’s left is to mail in or walk the check in to the tax collector’s office and collect your receipt. Given how late in the year it is, I chose to physically go to the office; one of the benefits of living in such a dense city is it took me less than 20 minutes to get there, and one of the benefits of the holiday period is that there was no line.
That’s it, you’re done.
Enjoy your tax savings of several hundred to several thousand dollars!
Do you qualify for this strategy? Any other last-minute actions you’re taking because of the passage of the new tax bill?
Caveat: As I’m not a tax expert, you should consult a tax professional if you’d like to confirm the accuracy of this strategy.