After months of telling California taxpayers that the only deductible real property taxes are those assessed on the basis of value, i.e., ad valorem taxes, the Franchise Tax Board recently acknowledged that its advice was wrong. Amended returns should be filed by taxpayers who, based upon this erroneous advice, underreported their deductible real property taxes.
California tax law follows the federal tax law in this area. Nevertheless, even though the IRS, in a Chief Counsel Memorandum, expressly opined that Mello-Roos and other California assessments may be deductible as real property taxes, despite not being imposed on an ad valorem basis, the Franchise Tax Board (“FTB”) publically adopted a contrary position, apparently based upon the 2011 Instructions for Schedule A (Form 1040). Subsequently, the FTB sent a letter to the IRS Chief Counsel asking for clarification. The IRS responded on February 6, 2012, stating that although section 164(b)(1) of the Internal Revenue Code requires a personal property tax be an ad valorem tax in order to be deductible, no such limitation applies to the deduction for real property taxes. Indeed, the letter from the IRS Chief Counsel states that “there is no statutory or regulatory requirement that a real property tax be an ad valorem tax to be deductible for federal income tax purposes.” Rather, taxes paid on real property assessments may be deductible if they are levied: (1) for the general public welfare; (2) by a proper taxing authority; (3) at a like rate; and (4) on owners of all properties in the taxing authority’s jurisdiction. Assessments levied on specific properties for a local benefit (such as for streets, sidewalks, and like improvements) are not deductible, however, unless they are imposed to repair, maintain, or meet interest charges for such benefits.
We applaud the FTB for correcting its position and removing materials from its website that stated the deductibility of real property taxes is limited to those taxes imposed on an ad valorem basis. Many practitioners, however, have wondered why the FTB delayed until mid- April to announce the change, because by then undoubtedly thousands of California returns (presumably including all of the FTB employees’ returns) have been filed based on the FTB’s erroneous advice.