How might the cap on the property tax deduction affect your taxes?

Man sitting at kitchen table, head resting on his folded arms, looking at a calculator and wondering how tax reform will affect his property tax deduction.Image: Man sitting at kitchen table, head resting on his folded arms, looking at a calculator and wondering how tax reform will affect his property tax deduction.

In a Nutshell

If you own real estate and itemize your deductions, you probably took a federal tax deduction in 2017 for the property taxes you paid that year. A new cap on the property tax deduction going into effect in 2018 could mean a bigger tax bill.
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This article was fact-checked by our editors and Jennifer Samuel, senior product specialist for Credit Karma.

Every year, millions of Americans claim a deduction for their property taxes on their federal income tax returns — and tax reform has capped that deduction starting this year.

According to the most-recent IRS data, around 37.54 million individual federal income tax returns claimed property tax deductions totaling more than $187 billion in 2015. Approximately 32.96 million returns deducted state and local income taxes, totaling more than $334 billion, and close to 9.55 million deducted more than $16.7 billion in sales taxes paid to their state or local governments.

Collectively, all these deductions are referred to as the SALT deduction, which is shorthand for state and local tax deduction.

The SALT deduction is intended to allow taxpayers to avoid paying federal taxes on the taxes they pay to their states within the same tax year. Money sent to the state could traditionally be deducted from taxable income to reduce federal taxes owed.

The Tax Cuts and Jobs Act of 2017 put a cap on the SALT deduction, including property taxes. The new cap, along with changes that tax reform made to the standard deduction, could persuade fewer taxpayers to itemize.

SALT basics

To deduct your property taxes — and other SALT taxes — you must itemize deductions on your federal income tax return. For 2015, nearly 45 million tax returns included itemized deductions, according to IRS data. And about 84% of itemizers took a property tax deduction.

And while taxpayers must choose between deducting state income taxes or sales taxes, more than 95% of returns that itemized deductions claimed one of the two, deducting a combined $351,163,796,000.

Why does this matter?

It’s largely because millions of people who took these deductions could see them capped starting in 2018, thanks to the Tax Cuts and Jobs Act. Under this tax reform bill, which was signed into law in December 2017, taxpayers are allowed to deduct a maximum of $10,000 ($5,000 for married taxpayer filing a separate return) for all state and local taxes paid in a tax year — including property taxes, and income taxes or sales taxes. This cap is in effect from 2018 until Dec. 31, 2025.

How will your property tax deduction be affected?

The SALT cap won’t affect everyone equally.

If you took a standard deduction in 2017 instead of itemizing — and you don’t plan to change that — the cap won’t affect your taxes because you couldn’t deduct state or local taxes anyway. And if you do plan to itemize but your total state and local taxes (including income or sales, and property taxes) don’t exceed $10,000, you also won’t be affected.

The SALT deduction cap won’t affect every taxpayer who used to itemize either, as itemizing makes far less sense for many filers under tax reform thanks to the increased standard deduction.

In 2017, single filers could take a standard deduction of $6,350. Heads of household could deduct $9,350, and married couples filing jointly could deduct $12,700. Tax reform increased the standard deduction to $12,000 for single filers, $18,000 for heads of household and $24,000 for married couples filing jointly.

Unless all their combined deductions — such as mortgage interest, state and local taxes, medical expenses and charitable contributions — exceed this higher standard deduction, it might not make sense anymore for many taxpayers to itemize. If that’s your situation, the SALT cap won’t matter to you.

Taxpayers who will feel the impact of the new SALT cap are filers with more than $12,000, $18,000 or $24,000 in total deductions — if more than $10,000 of those deductions come from taxes paid in combined property tax and state income tax or state sales tax.

Residents of high-tax states will be hit hardest

While high-income property-owning taxpayers across the country will lose valuable federal tax deductions, residents of different states will be impacted in different ways. Some taxpayers will be far more likely to see their federal deductions reduced in 2018.

Pew Charitable Trusts reports that in 2015 tax filers in 19 states and Washington, D.C., on average took SALT deductions above the new $10,000 cap: California, Connecticut, Illinois, Iowa, Maine, Maryland, Massachusetts, Minnesota, Nebraska, New Hampshire, New Jersey, New York, Ohio, Oregon, Pennsylvania, Rhode Island, Virginia, Vermont and Wisconsin. Among these states, residents of California, Connecticut, Massachusetts, New Jersey and New York had average SALT deductions that exceeded $15,000.

Pew notes that while these states are primarily in the Northeast, upper Midwest and West, they are diverse in population size, and that the claim rate per state doesn’t necessarily keep pace with the average claim amount. For example, New York has the highest per-claimant average at $22,169, yet a claim rate of 35%. Meanwhile, Maryland, where the average claim is more than $10,000 less than New York’s average, has a claim rate of 46% — the highest rate listed.

These big discrepancies exist because some states don’t impose state income taxes, while also keeping other taxes low, whereas other states impose a substantial tax burden. In the 2016–2017 tax year, for example, New York (which has a state income tax) collected around $79 billion in taxes from residents, while Texas (no state income tax) collected around $53 billion — despite New York having a smaller population.

States classified as “blue” states, which traditionally vote democratic, tend to impose higher state and local taxes than those classified as “red” states, which tend to vote republican. This discrepancy prompted some blue state governors to warn that the SALT cap could have a disproportionate impact on their residents.

States vs. the IRS on work-arounds

Many of the states whose residents are likely to be hit hardest by the SALT deduction cap, particularly for property tax deduction, have begun looking for workarounds to offset the cap, including …

● A lawsuit brought by New York, Connecticut, Maryland and New Jersey seeking an injunction to invalidate the $10,000 cap on SALT deductions. The lawsuit alleges that the cap overturns 150 years of tax precedent essential to preventing the federal government from interfering with the states’ authority to set local tax policy.
● Proposals in the New York state budget to allow New Yorkers to reduce state tax liability by making charitable contributions to a fund benefitting New Yorkers, since charitable contributions remain deductible from federal taxes. The budget also allowed for the optional implementation of a new payroll tax to replace a portion of employees’ state income taxes, as payroll taxes remain deductible for employers.
● The passage of a bill in Connecticut, S.B. 11, which imposes a new tax on pass-through entities such as S-corps. The new tax is deductible from federal taxable income and offset by a personal income tax credit. The bill also allows for property tax credits to individual Connecticut taxpayers who donate to designated community-supporting charitable organizations.
● The passage of New Jersey Senate Bill 1893, which allows for local governments to create charitable funds that New Jersey residents can contribute to in order to offset up to 90% of their property taxes, effectively converting those taxes into charitable contributions.

In response to these efforts, the IRS proposed regulations on how it will treat charitable contributions and state and local tax credits. The IRS had previously put states on notice that federal law – and not state law – controls what is considered a tax payment and what is considered a charitable contribution for the purposes of determining deductibility from federal income taxes.

In its proposed regulations issued in August 2018, the IRS says any taxpayer who makes a contribution of cash or property to an eligible entity in order to receive a charitable contribution deduction will have to “reduce their (federal) charitable deduction by the amount of any state or local tax credit the taxpayer receives or expects to receive.”

There is an exception: if the state tax deduction or credit is no more than 15% of the contribution amount – or the fair market value in the case of a property donation – the taxpayer will not have to reduce their federal charitable deduction by the state credit or deduction amount.

The proposed regulations are open for public comment and it’s likely states that have sought to work around the SALT deduction cap will have a lot to say about the regulations.

What can you do if you’re losing part of your property tax deduction?

If you’ll be losing your ability to take a full property tax deduction — or to otherwise deduct taxes paid to state and local governments — you can try to offset the loss by ensuring you’re claiming all deductions and credits you may be eligible for. These could include …

  • The mortgage interest deduction: For property owners who purchased homes prior to Dec. 14, 2017, interest is deductible for mortgages up to $1 million, or $500,000 if married filing separately. For loans issued after Dec. 14, 2017, through Dec. 31, 2025, interest is deductible on mortgages up to $750,000, or $375,000 if married filing separately.
  • Interest on qualifying home equity loans and lines of credit: Interest on home equity loans or lines of credit is deductible when the money is used to purchase, build or make substantial improvements to the home. However, the $750,000 cap applies, so the total deductible amount from both your primary mortgage as well as any equity loans can’t exceed this amount.
  • Deductions for energy-efficient home improvements: Homeowners can claim tax credits for certain residential renewable-energy projects through 2021, including solar electric and solar heating.

Taxpayers should also first determine if the higher standard deduction would now provide a larger reduction in taxable income than itemizing, given new limitations on the SALT deduction, mortgage interest and other deductions.

Bottom line

For some taxpayers, the SALT cap could lead to losing a portion of their property tax deduction or deduction for other local taxes. Whether the cap affects you depends on how much your total state and local tax burden is, whether it make sense for you to itemize, and whether your state is able to find a successful workaround that the IRS allows.

Jennifer Samuel, senior tax product specialist for Credit Karma, has more than a decade of experience in the tax preparation industry, including work as a tax analyst and tax preparation professional. She holds a bachelor’s degree in accounting from Saint Leo University. You can find her on LinkedIn.

About the author: Christy Rakoczy Bieber is a full-time personal finance and legal writer. She is a graduate of UCLA School of Law and the University of Rochester. Christy was previously a college teacher with experience writing textbo… Read more.