NATION’S HOUSING : Homeowners Taking Excess Tax Deductions

A top tax expert for Congress’ investigative agency has an urgent message for American homeowners: Stop taking property tax deductions you’re not entitled to under law. It’s costing Uncle Sam hundreds of millions of dollars a year in lost revenues. And it could also get you into hot water if you get audited.

Testifying before a House subcommittee in late September, Natwar M. Gandhi, associate director for tax policy of the General Accounting Office (GAO), said excess property tax write-offs by homeowners on their federal tax returns have mushroomed into at least a $2 billion-per-year problem--and probably far larger.

Homeowners take illegal write-offs, according to Gandhi, when they lump non-deductible payments for local government services in with their property tax payments, which are deductible. They also overstate their deductions when they fail to report property tax rebates provided by local governments under various programs.

For example, say your county, city or local taxing authority charges you $3,000 a year in real estate taxes, based on the assessed valuation of your home. Along with that bill it sends you additional charges for garbage collection, your household water consumption and other miscellaneous service fees totaling $750. Under the federal income tax code, you are entitled to write off the $3,000 at tax time. But you’re not supposed to write off the $750. Even if the bottom line on your property tax bill reads $3,750, legally you’re expected to distinguish between the non-deductible $750 and the deductible $3,000.

The Internal Revenue Service’s rules say your payment to a local government authority must meet three tests to be deductible:

--It’s a charge based on the assessed valuation of your property and not on some other standard;

--The same assessment-based format is used uniformly on all other properties in your community, and

--The money collected is used for either general governmental purposes or for specific community-wide functions such as funding the local public school system.

If the money you send to your local taxing agency fits those criteria, it should be deductible on your federal tax return even if the bill you get calls it something other than a “property tax” levy.

On the other hand, if you are billed a special assessment for some improvement that will enhance the value of your home--like the construction costs of a new tennis court for the exclusive use of you and your neighbors--the charge is not deductible.

So, too, for direct fees based on your household usage of municipal services such as water and sewage. These are user fees, proportional to your own consumption and, therefore, non-deductible.

But how many home-owning taxpayers understand the fine points of the law? Apparently not many, according to GAO’s research. Even in communities where local government tax bills clearly distinguish “user fees” from the property tax levy, as many as nine out of 10 tax returns examined by the agency erroneously sought write-offs for the entire bill.

Gandhi says, “We could not determine whether taxpayers intentionally overstated the deductions.” But he believes two major factors are producing the billions of dollars in excess write-offs.

1--Homeowners and private tax preparers often are totally in the dark about the issue. So are many mortgage servicing firms who pay the tax bills from escrow accounts, and then report the full amounts to homeowners annually as their “property taxes.”

2--Local government forms often are “confusing” in Gandhi’s opinion. From a survey of property tax bills used by 55 of the largest tax-collecting jurisdictions in the country--from San Francisco to Baltimore--GAO investigators concluded that the overwhelming majority either made “unclear distinctions between user fees and real estate taxes” or made no distinctions whatsoever.

So how are audit-averse homeowners, who want to comply with the law, supposed to figure their correct deductions for calendar 1993? For starters, if your tax bill isn’t clear on the subject of user fees, ask your local government for an item-by-item breakdown of your bill. Then you can use the criteria listed above to see where they fit.

If you are the recipient of a property tax rebate--for instance, a partial refund of taxes for senior homeowners--be sure you report it as income in the year you receive it. The GAO found that non-reporting of rebates is another noteworthy hole in the federal revenue bucket.

And what if you discover that you’re one of the estimated millions of homeowners who have been over-deducting on property taxes inadvertently for years? Should you ‘fess up and file amended returns along with a check?

IRS officials would be bowled over if you did. But talk to your tax adviser--or alternatively your spiritual adviser--before undertaking such saintliness.