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Income Tax

Deductions for Tax
by

Gary Barton

on 19 November 2012

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Transcript of Income Tax

Taxes that are deductible are governed primarily by Section 164 Deductible Taxes Until 1986, § 164 allowed a deduction for sales tax, but was repealed as part of the Tax Reform Act of 1986.
Following the repeal of the sales tax deduction, a taxpayer who was a resident of a state that relied heavily on sales tax for revenue paid more federal tax than a taxpayer with equal income who was a resident of a state that relied more heavily on income and property taxes.
Therefore, the American Jobs Creation Act of 2004 was passed and amended § 164.
This amendment allows taxpayers to elect to take either a sales tax deduction OR a deduction for sate and local income taxes. (See § 164(b)(5)). Income Tax or Sales Tax? States with a Sales Tax but no Income Tax As a result of the amendment, taxpayers who live in states with an income tax generally will not elect to take the sales tax deduction because their deduction for state and local income taxes will generally exceed the deduction for state and local sales taxes.


Conversely, taxpayers who live in states with a sales tax but no income tax will elect to take the sales tax deduction.

WARNING: this optional deduction expires 12/31/2011 unless extended!!! Sales Tax Deduction v. Income Tax Deduction To be deductible, the tax must be imposed on the taxpayer and must have been paid during the tax year.
Must be taken as an itemized deduction on Form 1040, Schedule A: The § 164 Deduction State, Local, and Foreign Real Property Taxes Definitions --§ 164(b)(1) :
The term "personal property tax" means an ad valorem tax which is imposed on an annual basis in respect of personal property. State and Local Personal Property Taxes State, Local, and Foreign State and Local Sales Tax State and local income taxes withheld from a taxpayer's wages during the year are deductible in the year they were withheld.

Foreign income taxes usually qualify as an itemized deduction or as a tax credit in the year they were paid.

Federal income taxes are not deductible. (Reg. § 1.164-2(a)). To claim the sales tax deduction, you can either add up all sales tax paid for the year (if you have the receipts) or you can claim a standard amount based on your state and income level. Sales Tax, continued... Deductible Non-Business Taxes Gary Barton
Kenny Farah
Katie Heflin HYPO 1 HYPO 2 Carl soon is rolling in the money from his thriving tax practice. He finds a sweet new bachelor pad to better suit his needs. On January 1 of year two, Carl purchases Bacheloracre from Henry. At the time of the purchase, Henry owes $5,000 in property taxes on Bacheloracre for year one. Carl pays the year one taxes Henry owes in order to obtain clear title to the property. Can Carl deduct all $5,000 of year one tax that he pays in year two? HYPO 4 No. The §164 deduction for taxes paid is applicable only to taxes owed by the taxpayer. In this case, Henry, not Carl, owed the year one property taxes. Carl would not be able to deduct the $5,000 of Henry's taxes that he paid, but he would be able to add the $5,000 payment to his basis in Bacheloracre. Henry would include in the amount realized on the sale the $5,000 of tax paid on his behalf by Carl and would take a §164 deduction in the same amount. HYPO 4 Well What Is a Motor Vehicle? (D) Qualified motor vehicle
For purposes of this paragraph—
(i) In general The term “qualified motor vehicle” means—
(I) a passenger automobile or light truck which is treated as a motor vehicle for purposes of title II of the Clean Air Act, the gross vehicle weight rating of which is not more than 8,500 pounds, and the original use of which commences with the taxpayer,
(II) a motorcycle the gross vehicle weight rating of which is not more than 8,500 pounds and the original use of which commences with the taxpayer, and
(III) a motor home the original use of which commences with the taxpayer.
(ii) Other terms The terms “motorcycle” and “motor home” have the meanings given such terms under section 571.3 of title 49, Code of Federal Regulations (as in effect on the date of the enactment of this paragraph). Limitations on Motor Vehicle Purchase (B) Limitation based on vehicle price
The amount of any State or local sales or excise tax imposed on the purchase of a qualified motor vehicle taken into account under subparagraph (A) shall not exceed the portion of such tax attributable to so much of the purchase price as does not exceed $49,500. (Sold for
$4.6 Million) Further Limitations on Eligibility for Motor Vehicle Deduction (C) Income limitation
The amount otherwise taken into account under subparagraph (A) (after the application of subparagraph (B)) for any taxable year shall be reduced (but not below zero) by the amount which bears the same ratio to the amount which is so treated as—
(i) the excess (if any) of—
(I) the taxpayer’s modified adjusted gross income for such taxable year, over
(II) $125,000 ($250,000 in the case of a joint return), bears to
(ii) $10,000. (d) Apportionment of taxes on real property between seller and purchaser
(1) General rule
For purposes of subsection (a), if real property is sold during any real property tax year, then—
(A) so much of the real property tax as is properly allocable to that part of such year which ends on the day before the date of the sale shall be treated as a tax imposed on the seller, and
(B) so much of such tax as is properly allocable to that part of such year which begins on the date of the sale shall be treated as a tax imposed on the purchaser. Real Property Taxes Continued... (2) Special rules
(A) in the case of any sale of real property, if—
(i) a taxpayer may not, by reason of his method of accounting, deduct any amount for taxes unless paid, and
(ii) the other party to the sale is (under the law imposing the real property tax) liable for the real property tax for the real property tax year,
then for purposes of subsection (a) the taxpayer shall be treated as having paid, on the date of the sale, so much of such tax as, under paragraph (1) of this subsection, is treated as imposed on the taxpayer. For purposes of the preceding sentence, if neither party is liable for the tax, then the party holding the property at the time the tax becomes a lien on the property shall be considered liable for the real property tax for the real property tax year. More Rules for Real Property... (B) In the case of any sale of real property, if the taxpayer’s taxable income for the taxable year during which the sale occurs is computed under an accrual method of accounting, and if no election under section 461 (c) (relating to the accrual of real property taxes) applies, then, for purposes of subsection (a), that portion of such tax which—
(i) is treated, under paragraph (1) of this subsection, as imposed on the taxpayer, and
(ii) may not, by reason of the taxpayer’s method of accounting, be deducted by the taxpayer for any taxable year,
shall be treated as having accrued on the date of the sale. What Does That All Mean for Real Property? Deductible real estate taxes are generally any state, local, or foreign taxes on real property. They must be charged uniformly against all property in the jurisdiction and must be based on the assessed value. Many states and counties also impose local benefit taxes for improvements to property, such as assessments for streets, sidewalks, and sewer lines. These taxes cannot be deducted. However, you can increase the cost basis of your property by the amount of the assessment. If you bought or sold real estate during the year, the real estate taxes must be divided between the buyer and the seller. The buyer and the seller must divide the real estate taxes according to the number of days in the real property tax year (the period to which the tax is imposed relates) that each owned the property. The seller is treated as paying the taxes up to, but not including, the date of sale. The buyer is treated as paying the taxes beginning with the date of sale. Cramer v. Commissioner Page 525 Real Estate Related Taxes you CANNOT Deduct Payments for the following items generally are not deductible as real estate taxes.

Taxes for local benefits.

Itemized charges for services (such as trash and garbage pickup fees).

Transfer taxes (or stamp taxes).

Rent increases due to higher real estate taxes.

Homeowners' association charges. Two basic rules that come out of this case:

1. "Section 164 allows a deduction for real property taxes but they are, in general, deductible only by the person upon whom thy are imposed."
Sec. 1.164-1(a), Income Tax Regs.

2. When selling property, one cannot claim deductions for the entire year that the taxes would have been imposed, must be proportioned out. Nope…

§164(a) states that taxes “paid or accrued by the taxpayer in connection with an acquisition or disposition of property shall be treated as part of the cost of the acquired property.” Thus, the $2,750 would not be deductible, but would instead be considered a part of the cost of the house. Answer Taxes for local benefits.
Itemized charges for services (such as garbage pickup fees).
Transfer taxes (or stamp taxes).
Rent increases due to higher real estate taxes.
Homeowners’ association charges. Real Estate-Related Items You Cannot Deduct No…

Under §1001(b), if the seller pays property taxes allocable to the buyer, the taxes allocable to the buyer reduce the seller’s amount realized and the buyer’s basis in the property acquired. So, both Gary’s amount realized and Kenny’s basis in the property acquired would be reduced by $1,375. Answer Under §1001(b), if the buyer pays property taxes allocable to the seller, the seller’s property taxes paid by the buyer increase the seller’s amount realized and the buyer’s basis in the property acquired. So, both Gary’s amount realized and Kenny’s basis in the property acquired would increase by $2,750. What Would the $2,750 Count for? Cited by Cramer v. Commissioner on p. 525 of your book.
During 1936 and 1937, the Supplee family purchased various plots of real estate in Baltimore.
For each purchase, the state and city taxes on the real estate for the current year had not been paid at the time of purchase.
Adjustments were made in the various contracts that provided for the apportionment of the real estate taxes.
Supplees agreed to pay the amount of the taxes, and the vendors agreed to bear the burden of that portion of the taxes allocable to the fraction of the year that had expired prior to the date of purchase. Magruder v. Supplee, 316 U.S. 394 (1942). Law school heartthrob Kenny decides to buy a bigger house. In November of 2011, he calls Gary, who is selling his house and moving to Alaska to “find himself.” At the end of the year, Gary owes $2,750 in property taxes on the house for 2011. Kenny purchases the house on January 1, 2012 and agrees to pay the $2,750 in property taxes for 2011. Can Kenny deduct the $2,750 for the 2011 taxes that he paid? Example …Notwithstanding [state and local, and foreign, taxes paid or accrued in carrying on trade or business], any tax (not described in the first sentence of this subsection) which is paid or accrued by the taxpayer in connection with an acquisition or disposition of property shall be treated as part of the cost of the acquired property or, in the case of a disposition, as a reduction in the amount realized on the disposition. Acquisition or Disposition of Property Under 164(a) Usually, as in the previous example, the purchase agreement includes language indicating that real estate taxes will be split between the buyer and seller based on the date of the sale.
But sometimes, the buyer will agree to pay the real estate taxes for the full year regardless of the date of purchase.
The buyer might even agree to pay delinquent real estate taxes from prior years as part of the purchase agreement. Let’s Get Weird Yes! You are absolutely right! They can deduct $2,047.60!
The Maglements sold their old house on May 31, so they owned it for 150 days of 2011 (January 1-May 30). They bought their new home on May 15, so they owned it for 230 days of 2011 (May 15-December 31).

150/365 = .4110; .4110 x 1,657 = 681.03
+
230/365 = .6301; .6301 x 2,168 = 1366.57
$2,047.60 Answer (d) Apportionment of taxes on real property between seller and purchaser.--
(1) General rule.--For purposes of subsection (a), if real property is sold during any real property tax year, then--
(A) so much of the real property tax as is properly allocable to that part of such year which ends on the day before the date of the sale shall be treated as a tax imposed on the seller, and
(B) so much of such tax as is properly allocable to that part of such year which begins on the date of the sale shall be treated as a tax imposed on the purchaser. 164(d)(1) Any state, local, or foreign taxes on real property levied for the general public welfare.
- I.R.S. Publication 17 (2011)

I.R.C. 164(a) and (d)(1)
I.R.C. 1001(b)
Reg. § 1.1001-1(b) Deductible Real Estate Taxes Deductible Real Estate and Personal Property Taxes Personal property tax is deductible if it is a state or local tax that is:
- I.R.S. Publication 17 (2011) Personal Property Taxes Remix. Kenny bought the house on July 1, 2011. This time, their agreement on the payment of the taxes was different. At the beginning of 2012, Gary paid all of the taxes on the house. Kenny then reimbursed Gary for the second half of the year’s taxes. Would this be the same as before? Now Usually I Don’t Do This, But Uh… The Supplees deducted the taxes paid on the properties, some of which were not allocable to them.
The IRS was not pleased, and the Supreme Court took their side.
The sellers of the properties were still liable for the payment of the taxes allocable to them. The only burden on the Supplees was “contractually assumed.”
“This was clearly the payment of a tax imposed upon another and therefore not deductible by respondents.”
“Parties cannot change the incidence of local taxes by their agreement… Such taxes are simply one form of raising revenue for the support of government. They are not like rent, nor are they paid for the privilege of occupying property for any given period of time.” Magruder v. Supplee, 316 U.S. 394 (1942). Adorable married couple Cory and Jordan Maglements have a nice little home in Tech Terrace, but they decide they need more room for activities, such as scrapbooking and interpretive dance. So, after a few days of searching, they find the perfect house and buy it on May 15, 2011. On May 31, they are able to sell their old home to Justin. The tax for 2011 on the old house was $1,657, and $2,168 on the new house. How much of this can the Maglements deduct from their 2011 taxes? Example How Much Can I Deduct?
Reg. § 1.1001-1(b)
(b) Amount realized.--The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received. In determining the amount realized--
(1) there shall not be taken into account any amount received as reimbursement for real property taxes which are treated under section 164(d) as imposed on the purchaser, and
(2) there shall be taken into account amounts representing real property taxes which are treated under section 164(d) as imposed on the taxpayer if such taxes are to be paid by the purchaser. What Does it all Mean?
Nobody Knows What it Means, but it’s Provocative. It Gets the People Goin’. No…

Under §1001(b), if the seller pays property taxes allocable to the buyer, the taxes allocable to the buyer reduce the seller’s amount realized and the buyer’s basis in the property acquired. So, both Gary’s amount realized and Kenny’s basis in the property acquired would be reduced by $1,375. Answer Nope…

§164(a) states that taxes “paid or accrued by the taxpayer in connection with an acquisition or disposition of property shall be treated as part of the cost of the acquired property.” Thus, the $2,750 would not be deductible, but would instead be considered a part of the cost of the house. Answer Law school heartthrob Kenny decides to buy a bigger house. In November of 2011, he calls Gary, who is selling his house and moving to Alaska to “find himself.” At the end of the year, Gary owes $2,750 in property taxes on the house for 2011. Kenny purchases the house on January 1, 2012 and agrees to pay the $2,750 in property taxes for 2011. Can Kenny deduct the $2,750 for the 2011 taxes that he paid? Example Usually, as in the previous example, the purchase agreement includes language indicating that real estate taxes will be split between the buyer and seller based on the date of the sale.
But sometimes, the buyer will agree to pay the real estate taxes for the full year regardless of the date of purchase.
The buyer might even agree to pay delinquent real estate taxes from prior years as part of the purchase agreement. Let’s Get Weird Adorable married couple Cory and Jordan Maglements have a nice little home in Tech Terrace, but they decide they need more room for activities, such as scrapbooking and interpretive dance. So, after a few days of searching, they find the perfect house and buy it on May 15, 2011. On May 31, they are able to sell their old home to Justin. The tax for 2011 on the old house was $1,657, and $2,168 on the new house. How much of this can the Maglements deduct from their 2011 taxes? Example Deductible Real Estate and Personal Property Taxes Personal property tax is deductible if it is a state or local tax that is:
- I.R.S. Publication 17 (2011) Personal Property Taxes Under §1001(b), if the buyer pays property taxes allocable to the seller, the seller’s property taxes paid by the buyer increase the seller’s amount realized and the buyer’s basis in the property acquired. So, both Gary’s amount realized and Kenny’s basis in the property acquired would increase by $2,750. What Would the $2,750 Count for? The Supplees deducted the taxes paid on the properties, some of which were not allocable to them.
The IRS was not pleased, and the Supreme Court took their side.
The sellers of the properties were still liable for the payment of the taxes allocable to them. The only burden on the Supplees was “contractually assumed.”
“This was clearly the payment of a tax imposed upon another and therefore not deductible by respondents.”
“Parties cannot change the incidence of local taxes by their agreement… Such taxes are simply one form of raising revenue for the support of government. They are not like rent, nor are they paid for the privilege of occupying property for any given period of time.” Magruder v. Supplee, 316 U.S. 394 (1942). Cited by Cramer v. Commissioner on p. 525 of your book.
During 1936 and 1937, the Supplee family purchased various plots of real estate in Baltimore.
For each purchase, the state and city taxes on the real estate for the current year had not been paid at the time of purchase.
Adjustments were made in the various contracts that provided for the apportionment of the real estate taxes.
Supplees agreed to pay the amount of the taxes, and the vendors agreed to bear the burden of that portion of the taxes allocable to the fraction of the year that had expired prior to the date of purchase. Magruder v. Supplee, 316 U.S. 394 (1942). Yes! You are absolutely right! They can deduct $2,047.60!
The Maglements sold their old house on May 31, so they owned it for 150 days of 2011 (January 1-May 30). They bought their new home on May 15, so they owned it for 230 days of 2011 (May 15-December 31).

150/365 = .4110; .4110 x 1,657 = 681.03
+
230/365 = .6301; .6301 x 2,168 = 1366.57
$2,047.60 Answer (d) Apportionment of taxes on real property between seller and purchaser.--
(1) General rule.--For purposes of subsection (a), if real property is sold during any real property tax year, then--
(A) so much of the real property tax as is properly allocable to that part of such year which ends on the day before the date of the sale shall be treated as a tax imposed on the seller, and
(B) so much of such tax as is properly allocable to that part of such year which begins on the date of the sale shall be treated as a tax imposed on the purchaser. 164(d)(1) Any state, local, or foreign taxes on real property levied for the general public welfare.
- I.R.S. Publication 17 (2011)

I.R.C. 164(a) and (d)(1)
I.R.C. 1001(b)
Reg. § 1.1001-1(b) Deductible Real Estate Taxes Taxes for local benefits.
Itemized charges for services (such as garbage pickup fees).
Transfer taxes (or stamp taxes).
Rent increases due to higher real estate taxes.
Homeowners’ association charges. Real Estate-Related Items You Cannot Deduct
Reg. § 1.1001-1(b)
(b) Amount realized.--The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received. In determining the amount realized--
(1) there shall not be taken into account any amount received as reimbursement for real property taxes which are treated under section 164(d) as imposed on the purchaser, and
(2) there shall be taken into account amounts representing real property taxes which are treated under section 164(d) as imposed on the taxpayer if such taxes are to be paid by the purchaser. What Does it all Mean?
Nobody Knows What it Means, but it’s Provocative. It Gets the People Goin’. …Notwithstanding [state and local, and foreign, taxes paid or accrued in carrying on trade or business], any tax (not described in the first sentence of this subsection) which is paid or accrued by the taxpayer in connection with an acquisition or disposition of property shall be treated as part of the cost of the acquired property or, in the case of a disposition, as a reduction in the amount realized on the disposition. Acquisition or Disposition of Property Under 164(a) How Much Can I Deduct? Remix. Kenny bought the house on July 1, 2011. This time, their agreement on the payment of the taxes was different. At the beginning of 2012, Gary paid all of the taxes on the house. Kenny then reimbursed Gary for the second half of the year’s taxes. Would this be the same as before? Now Usually I Don’t Do This, But Uh… Deductible Real Estate and Personal Property Taxes Any state, local, or foreign taxes on real property levied for the general public welfare.
- I.R.S. Publication 17 (2011)

I.R.C. 164(a) and (d)(1)
I.R.C. 1001(b)
Reg. § 1.1001-1(b) Deductible Real Estate Taxes (d) Apportionment of taxes on real property between seller and purchaser.--
(1) General rule.--For purposes of subsection (a), if real property is sold during any real property tax year, then--
(A) so much of the real property tax as is properly allocable to that part of such year which ends on the day before the date of the sale shall be treated as a tax imposed on the seller, and
(B) so much of such tax as is properly allocable to that part of such year which begins on the date of the sale shall be treated as a tax imposed on the purchaser. 164(d)(1) How Much Can I Deduct? Adorable married couple Cory and Jordan Maglements have a nice little home in Tech Terrace, but they decide they need more room for activities, such as scrapbooking and interpretive dance. So, after a few days of searching, they find the perfect house and buy it on May 15, 2011. On May 31, they are able to sell their old home to Justin. The tax for 2011 on the old house was $1,657, and $2,168 on the new house. How much of this can the Maglements deduct from their 2011 taxes? Example Yes! You are absolutely right! They can deduct $2,047.60!
The Maglements sold their old house on May 31, so they owned it for 150 days of 2011 (January 1-May 30). They bought their new home on May 15, so they owned it for 230 days of 2011 (May 15-December 31).

150/365 = .4110; .4110 x 1,657 = 681.03
+
230/365 = .6301; .6301 x 2,168 = 1366.57
$2,047.60 Answer Usually, as in the previous example, the purchase agreement includes language indicating that real estate taxes will be split between the buyer and seller based on the date of the sale.
But sometimes, the buyer will agree to pay the real estate taxes for the full year regardless of the date of purchase.
The buyer might even agree to pay delinquent real estate taxes from prior years as part of the purchase agreement. Let’s Get Weird There are 5 types of deductible non-business taxes:
State, local, and foreign income taxes
State, local, and foreign real estate taxes
State and local personal property taxes
State and local sales taxes, and
Qualified motor vehicle taxes (a) General rule
Except as otherwise provided in this section, the following taxes shall be allowed as a deduction for the taxable year within which paid or accrued:
(1) State and local, and foreign, real property taxes.
(2) State and local personal property taxes.
(3) State and local, and foreign, income, war profits, and excess profits taxes.
(4) The GST tax imposed on income distributions.
(5) The environmental tax imposed by section 59A.
(6) Qualified motor vehicle taxes.
American Jobs Creation Act Motor Vehicle Deduction (6) Qualified motor vehicle taxes
(A) In general
For purposes of this section, the term “qualified motor vehicle taxes” means any State or local sales or excise tax imposed on the purchase of a qualified motor vehicle.
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