Real Estate Tax Deduction: Taxpayers Face Challenges in Determining What Qualifies; Better Information Could Improve Compliance
Highlights
The Joint Committee on Taxation identified improved taxpayer compliance with the real-estate tax deduction as a way to reduce the federal tax gap--the difference between taxes owed and taxes voluntarily and timely paid. Regarding the deduction, GAO was asked to examine (1) factors that contribute to taxpayers including nondeductible charges, (2) the extent that taxpayers may be claiming such charges, (3) the extent that Internal Revenue Service (IRS) examinations focus on the inclusion of such charges, and (4) possible options for improving taxpayer compliance. GAO surveyed a generalizable sample of local governments, studied taxpayer compliance in two jurisdictions that met selection criteria, reviewed IRS documents, and interviewed government officials and others. Addressing the complexity of current tax law on real-estate tax deductions was outside the scope of this review.
Taxpayers who itemize federal income-tax deductions and whose local real-estate tax bills include nondeductible charges face challenges determining what real-estate taxes they can deduct on their federal income tax returns. Neither local-government tax bills nor mortgage-servicer documents identify what taxpayers can properly deduct. Without such information, determining deductibility can be complex and involve significant effort. While IRS guidance for taxpayers discusses what qualifies as deductible, it does not indicate that taxpayers may need to check both tax bills and other information sources to make the determination. In addition, tax software and paid preparers may not ensure that taxpayers only deduct qualified amounts. There are no reliable estimates for the extent of noncompliance caused by taxpayers claiming nondeductible charges, or the associated federal tax loss. However, GAO estimates that almost half of local governments nationwide included generally nondeductible charges on their bills. While the full extent of overstatement is unknown due to data limitations, GAO estimates that taxpayers in two counties collectively overstated their deductions by at least $23 (or $46 million using broader matching criteria). IRS examinations of real-estate tax deductions focus more on whether the taxpayer owned the property and paid the taxes than whether the taxpayer claimed only deductible amounts, primarily because nondeductible charges are generally small. IRS guidance does not require examiners to request proof of deductibility or direct them to look for nondeductible charges on tax bills. Various options could improve compliance with the real-estate tax deduction, such as providing taxpayers with better guidance and more information, and increasing IRS enforcement. However, the lack of information regarding the extent of noncompliance and the associated tax loss makes it difficult to evaluate these options. If IRS obtained information on real-estate tax bill charges, it could find areas with potentially significant noncompliance and use targeted methods to reduce noncompliance in those areas.
Recommendations
Recommendations for Executive Action
| Agency Affected Sort descending | Recommendation | Status |
|---|---|---|
| Internal Revenue Service | To help ensure that individual taxpayers are getting the best information and assistance possible from third parties on how to comply with the real-estate tax deduction, the Commissioner of Internal Revenue should reach out to local governments to explore options for clarifying charges on the local tax bills or adding disclaimers to these bills that some charges may not be deductible. |
Closed – Implemented
In 2010, IRS developed and distributed a brochure to local governments through the National Association of County Collectors, Treasurers, and Finance Officers (NACCTFO) that described and provided examples of what is and is not deductible relate to the real estate tax deduction. In the brochure, IRS suggested local governments consider modifying their tax bills to alert taxpayers that certain items are not allowable as deductions on their federal income tax returns.
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| Internal Revenue Service | To help ensure that individual taxpayers are getting the best information and assistance possible from third parties on how to comply with the real-estate tax deduction, the Commissioner of Internal Revenue should reach out to mortgage servicers to discuss adding disclaimers to their annual statements that some charges may not be deductible. |
Closed – Implemented
In 2010, IRS developed a brochure for distribution to mortgage escrow firms and others that described and provided examples of what is and is not deductible related to the real-estate tax deduction. In the brochure, IRS suggested that mortgage companies consider modifying escrow statements to alert taxpayers that certain items are not allowable as deductions on their federal income tax returns.
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| Internal Revenue Service | To help ensure that individual taxpayers are getting the best information and assistance possible from third parties on how to comply with the real-estate tax deduction, the Commissioner of Internal Revenue should reach out to tax-preparation software firms and other tax preparers to ensure that they are alerting taxpayers that some local charges are not deductible and that they are aware of any enhancements to IRS's guidance. |
Closed – Implemented
In 2010, IRS developed and distributed a brochure to the Electronic Tax Administration (ETA) about what is and is not deductible related to the real-estate tax deduction. The brochure provided examples to help tax preparation software firms and other tax preparers and their customers identify allowable deductions related to the real-estate tax.
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| Internal Revenue Service | To improve IRS's guidance to its examiners auditing the real-estate tax deduction, the Commissioner of Internal Revenue should revise the guidance to indicate that evidence of deductibility should not rely on mortgage escrow statements, Forms 1098, and cancelled checks (which can be evidence of payment), and may require more than reliance on a real-estate tax bill. |
Open
No executive action taken. IRS has not addressed this action and had no plans to do so as of March 2024. IRS did not agree with GAO's May 2009 recommendation and the agency maintains that existing examination guidance provides examiners with sufficient information to properly examine this deduction. For tax years beginning after December 31, 2016, section 11042 of Public Law 115-97 caps the deduction for state and local taxes, including real estate taxes, at $10,000. GAO maintains that examiners are continuing to rely on guidance that is inadequate to properly examine this deduction and that action should be taken to clarify the guidance.
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| Internal Revenue Service | To improve IRS's guidance to its examiners auditing the real-estate tax deduction, the Commissioner of Internal Revenue should revise the guidance to require examiners to ask taxpayers to substantiate the deductibility of the amounts claimed whenever they are examining the real-estate tax deduction and they have reason to believe that taxpayers have claimed nondeductible charges that are large, unusual, or questionable. |
Open
No executive action taken. IRS has not addressed this action and had no plans to do so as of March 2024. IRS did not agree with GAO's May 2009 recommendation and the agency maintains that existing examination guidance provides examiners with sufficient information to properly examine this deduction. For tax years beginning after December 31, 2016, section 11042 of Public Law 115-97 caps the deduction for state and local taxes, including real estate taxes, at $10,000. In its 2009 review, GAO found that some examiners were not confirming that taxpayers were entitled to deduct real estate charges claimed, even in situations where their deductibility may have been in question. As a result, GAO maintains that examiners are continuing to rely on guidance that is inadequate to properly examine this deduction and that action should be taken to clarify the guidance.
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| Internal Revenue Service | To learn more about where tax noncompliance is most likely, the Commissioner of Internal Revenue should identify a cost-effective means of obtaining information about charges that appear on real-estate tax bills in order to identify local governments with potentially large nondeductible charges on their bills. |
Closed – Implemented
An IRS team, coordinating during 2009 with the GAO team that did the work on the report, attempted to identify a cost-effective means of obtaining information on which local jurisdictions placed large nondeductible charges on their real estate tax bills. The IRS team concluded that no cost-effective means was available, after reviewing GAO's methodology and related data.
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| Internal Revenue Service | To learn more about where tax noncompliance is most likely, the Commissioner of Internal Revenue should, if such local governments are identified, obtain and use the information, including uses such as compliance research focused on nondeductible charges; outreach to such local governments to help them determine which charges are deductible charges and help affected taxpayers correctly compute the deduction; targeted outreach to the tax-preparation and mortgage-servicer industries, and targeted examinations of the real-estate tax deduction in the localities. |
Closed – Implemented
This recommendation is linked to the previous recommendation on finding a cost effective way to identify local jurisdictions that had large nondeductible charges on their real estate tax bills. Because IRS was unable to do so, IRS similarly could not target such jurisdictions for outreach and assistance on determining which charges are deductible on federal income tax returns. However, to meet the spirit of GAO's recommendation, IRS in 2010 distributed guidance to local jurisdictions that provided examples of what is deductible versus what is not and suggested that local governments consider modifying their tax bills to alert taxpayers that certain items are not allowable as deductions on their federal income tax returns.
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| Internal Revenue Service | To enhance IRS's guidance to help individual taxpayers comply in claiming the correct real-estate tax deduction, the Commissioner of Internal Revenue should place a stronger disclaimer early in the guidance to alert taxpayers to the need to check whether all charges on their real-estate tax bill are deductible. |
Closed – Implemented
IRS changed the instructions for Schedule A of the Form 1040, the federal income tax form where taxpayers can claim a deduction for real-estate taxes paid, by adding a disclaimer advising taxpayers to look at their real-estate tax bills to determine if any nondeductible charges are included in the tax bill.
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| Internal Revenue Service | To enhance IRS's guidance to help individual taxpayers comply in claiming the correct real-estate tax deduction, the Commissioner of Internal Revenue should clarify that real-estate tax bills may be insufficient evidence of deductibility when bills include nondeductible charges that are not clearly stated. |
Closed – Implemented
IRS made changes to sections of relevant publications and instructions clarifying that tax bills may not provide sufficient evidence of deductibility. Specifically, IRS changed instructions for Schedule A of form to caution taxpayers that they must use judgment in determining whether charges on their real estate tax bills are deductible. IRS also added a sentence to multiple publications in sections related to claiming deductions for real-estate taxes advising taxpayers to contact taxing authorities for additional information about potentially non-deductible charges.
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| Internal Revenue Service | To enhance IRS's guidance to help individual taxpayers comply in claiming the correct real-estate tax deduction, the Commissioner of Internal Revenue should provide information or a worksheet on steps to take to get information about whether bills include nondeductible charges and about what those charges are. |
Closed – Implemented
GAO recommended that IRS provide taxpayers with steps they can take to get information on potentially non-deductible real-estate-tax-related charges. Although IRS did not agree with this recommendation, IRS did agree to make changes to its guidance that met the spirit of the recommendation. Specifically, IRS added a sentence to its instructions and publications related to claiming real-estate tax deductions (Publication 17; Publication 530; and Form 1040, Schedule A) advising taxpayers to contact their taxing authority if they need additional information about specific charges on their tax bills.
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