 Income tax 2023-2024, itemized deductions, state and local real estate taxes. Get ready and some coffee so we can recognize the code cracks when doing income tax preparation 2023-2024. Most of this information can be found in the instructions for Schedule A Tax Year 2023, which you can find on the IRS website at irs.gov, irs.gov. Looking at the income tax formula, we're focused on what I would call the below-the-line deductions. More specifically, the itemized deductions. Remember, the first half of the income tax formula is basically a funny income statement. Most income statements having income minus expenses resulting in net income. Here having income minus various deductions resulting in taxable income, noting for taxes, deductions good. Therefore, we're looking for more of them. The difference between the above-the-line deductions or adjustments to income and the below-the-line deductions include the fact that the adjustments to income do not have to clear a hurdle such as the standard deduction before we get a benefit from them, whereas when we're looking at the itemized deductions, they do typically have to clear the hurdle of the standard deduction before they benefit us as taxpayers. Looking at the first page of the Form 1040, we're focused on line number 12, standard deduction or itemized deduction. We're focused on the itemized deduction, which we would take if it's greater than the standard deduction. And if that were the case, we would include the Schedule A. The Schedule A is the itemized deduction schedule. First, a word from our sponsor. Yeah, actually, we're sponsoring ourselves on this one because apparently the merchandisers, they don't want to be seen with us. But that's okay, whatever, because our merchandise is better than their stupid stuff anyways. Like our crunchy numbers is my cardio product line. Now, I'm not saying that subscribing to this channel, crunching numbers with us, will make you thin, fit, and healthy or anything. However, it does seem like it worked for her. Just saying. So, you know, subscribe, hit the bell thing and buy some merchandise so you can make the world a better place by sharing your accounting instruction exercise routine. If you would like a commercial free experience, consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com. We have some of the items on the left-hand side, although this is not the full schedule page. This has given us a layout of the standard deduction, the hurdle that we would have to clear, dependent largely on the filing status. Single filers having a standard deduction $13,850, married filing joint doubling to $27,700, head of household in the middle $20,800, and if over an age or blind, you would then have the added standard deduction depending on if one or two of those items are checked off for single versus one through four for two people if married and head of household, qualified widow and so on and so forth. All right, so now we're going to be continuing on with the state taxes. You will recall that in a federal income tax system, the general idea of an income tax is that we should be able to deduct those things that we have to consume in order to generate revenue so we're taxed not on gross income but net income, a concept most clearly seen with the Schedule C business deductions where we have in essence an income statement, income minus the expenses we had to spend in order to generate the income, the net income, then being the thing we apply the tax to. The Schedule A has a bunch of things that kind of deviate from that standard rule where we have personal items that we get a deduction from for whatever reason in the past. Now, this often comes up with complexities related to them. We're now looking at the state taxes, remembering state taxes and local taxes are different than the federal income taxes. Clearly, we can't deduct federal income taxes typically, at least like the income tax in order to then calculate the income tax because we would result in a circle reference. But what about the state taxes? Normally the answer would be in a pure kind of income tax system. No, you wouldn't get to deduct them because they're personal unless they were spent for the business. You bought something business related and had to pay state taxes, then you would think it would be like a business expense. But the IRS for whatever reason said we're going to deduct the state taxes. And so now we have the capacity to deduct certain state and local taxes. We talked about in the past, some of those being the state tax, like an income tax that the state might set up to take care of the things they are responsible for, such as local police firefighting and so on and so forth versus the federal government that should be mainly focused on protecting us, military. And then on the local side, they could pay for that with an income tax or possibly like a sales tax, whatever they wanted to do. We talked about those options. What about like real estate? That's another big one where we have basically a property tax type of situation on the main piece of property for most people that being a home. And this is probably one of the big factors that really helped the itemized deductions of the state taxes to stay in place on the schedule A. And I would think it's because of the lobbyist. My skeptical mind would say, well, it's because all of the people that are in the housing industry wants subsidies for housing. And therefore, mortgage interest, a personal expense and the real estate taxes related to the purchase of the home become very beneficial for those those interests. Right. So now we have the taxes on the home. Can we deduct the taxes on the home remembering that usually it's going to be a more well off individuals that have the ability to itemize because they have more itemized deductions and the main thing that pushes people over from taking the standard to itemize deductions is the ownership of the home primarily because of the loan or mortgage related to it and the interest expense on that mortgage, which could be deductible, but also significant to the ownership of the home are real estate taxes, which are often quite high in many areas. However, remember the real estate taxes have been limited a lot in a few years ago. So if you're in a high cost of living area, it's quite common that you could get capped on the deductibility of real estate taxes as they're included to like total state taxes. Also just keep in mind that you probably don't want to buy a house just so that you can itemize your deductions unless you've you've really calculated it out because there could be a big gap between the standard deductions you're taking and being able to itemize. And so we might touch in on that when we get to the software example problem, but just realize if someone says, hey, you get to deduct all 6000 of the taxes, plus you get to deduct the real the loan interest on the mortgage interest. And that's true. And you say, well, that's like 20,000 of a deduction. But if you were married before, you still might not be clearing it might not be enough to clear the itemized deductions or barely clear the itemized deductions. So the actual amount of benefit that you're getting could be substantially less than the itemized deductions that you're claiming on the Schedule A. So we'll see that more in the example problems. Tip. So if you are a homeowner who receives assistance under a state housing finance agency hardest hit fund program or an emergency homeowners loan program, you could see publication 530 for the amount you can include online 5B. So enter online 5B the state and local taxes you paid on real estate you own that wasn't used for business, but only if the taxes are assessed uniformly at a like rate on a real property throughout the community and the proceeds are used for general community or government purposes. Okay, let's take a look at that one more time. Enter online 5B the state and local taxes you paid on real estate. So we're basically talking about property state property taxes, real estate taxes, usually on the home because that's the property that most individuals own. But we're talking real estate taxes that wasn't used for business. Now you might say well why if it was used for business. That's when I should get the deduction because then I pay taxes as a normal ordinary business expense. And you might you might get the taxes deducted there but not on the schedule E. I mean, a in that case not an itemized deduction. You might then be able to take the deduction on a schedule C or whatever the business form was that you use for the business, which could be legitimate. That would be make more sense. However, if you use your home for both personal and business, we're going to see that we run into this kind of confusing problem again, in that we might have part of the deduction that maybe we can deduct on say a schedule C. And part of it that then possibly could still be deductible on a noting that we can't double dip deducting the same amount in both places. Okay, so but only if the taxes are assessed uniformly at a like rate on all real property throughout the community. So no special kind of arrangements and what not. So anyways and the proceeds are used for general community or governmental purposes. In other words, the money that's being used is not like it's going into a fund for you or something like that. It's used for the general governmental purposes of the state or locale. So our publication 530 explains the deductions the deductions homeowners can take. So you could take a look at that for more detail. Don't include the following amounts online 5B foreign taxes you paid on real estate. So we're talking about United States taxes here. So we're talking about the property taxes in the United States for real estate. So itemized charges for services to specific property or persons, for example, a $20 monthly charge for house per house for trash collection, a $5 charge for every 1000 gallons of water consumed, a $5 charge for mowing a lawn they had grown higher than permitted under a local ordinance. You can see this kind of makes sense because that's not exactly property tax. It's kind of like maintenance or required maintenance kind of things that are basically taking place in essence charges for the improvements that tend to increase the value of your property. For example, an assessment to build a new sidewalk. So clearly, if you would think it would kind of be a form of double dipping if you're paying if you're paying something in order to in order to increase the value of your property because obviously the incentive to do that would most likely to be to improve and increase the property value, which means you're getting kind of a benefit from it already. And so you would think it'd be kind of like double dipping if you got if you got a tax deduction with it too. But in any case the cost of property improvement is added to the basis of the property. So meaning the value of the property it might be included to the basis. Because that do the basis is kind of like the cost of the property. So when you sell the property, then you might have to calculate a gain or loss on the property if it's real estate property it might be like a capital gain or loss. But if it's personal property, then it still would be capital but you might have an exemption for it. But the general idea is that you would like to have a higher basis or cost in the property when you sell it. Because then when you calculate the gain, gains are bad for taxes. They're good in general but bad for taxes because they might trigger a tax event. So then you have the sales price minus the cost or basis. If you get to increase the value of the basis, then you're going to have less of a gain when you sell it and that could be a tax benefit. However, it might be totally wiped away if it's your home in any case because there is a substantial exclusion on the sale which we might talk about when we get to the capital gains. So however, a charge is deductible if it is used only to maintain an existing public facility and service. For example, a charge to repair an existing sidewalk and any interest included in that charge. So if your mortgage payments include your real estate taxes, you can include only amount the mortgage company actually paid to the Taxing Authority in 2023. So this gets a little bit into the logistics of this. So note that if you're dealing with somebody or yourself who is itemizing, most likely because you own a home which is a type of real estate. And that pushes you over because you're going to have a loan on it typically, a mortgage, which means you're going to be paying mortgage interest which is usually quite significant and something that the bank will typically tell you about. You're going to get forms documentation related to the mortgage interest which will help you to populate the mortgage interest part or deduction on Schedule A. Property taxes, though, what's the documentation that we're going to get with relation to property taxes? Now if it's not being paid through your mortgage company, which it may not, you might just be paying your own property taxes, then you might not get any documentation. Because the people that the state and the locale doesn't have a responsibility typically to inform the IRS and you of the property taxes with like a 1099 or 1098 or something like that. Therefore, you're just going to have to keep the bills and make sure that you are properly recording the property taxes typically in the year that you paid them mainly on a cashed-based system, although you have to be careful if you try to come up with a scheme of prepaying your property taxes, right? Because the IRS will limit that kind of thing typically. But sometimes when you pay your financial institution, they're going to say, hey, look, we'll make it easy on you. We'll just include the property taxes in the amount that you pay us. So when you pay your mortgage company, you're going to be paying them the principal and interest on the loan as well as an amount that will be evenly allocated monthly. That would be easier to budget. That would be their argument on why you might do that. And then they will take that money and pay it to the state and locale to pay your property taxes in essence for you. So if that's the case, you will probably get the form from your financial institution telling you the amount of interest you paid in the year, which could be deductible on Schedule A as interest. And the property taxes will be reported basically separately. What you don't get a deduction for is of course the principal, the pay-down of the loan itself. It's only the interest and the property taxes. Okay, so if you sold your home in 2023, any real estate tax charged to the buyer should be shown on your settlement statement. And in box six of any form 1099S you received, this amount is considered a refund of real estate taxes. See refunds and rebates later. So any real estate taxes you paid at closing should be shown on your settlement statement. So things get messy when there's a purchase and a sale of the real estate. So in the year of purchase or the year of sale, then as part of the agreement when there's a sale of real estate that takes place, there could be property tax that's outstanding at that point in time. And part of the agreement could be well who's going to be in charge of paying the property tax? Is it the person selling or is it the person purchasing? And those kind of details will typically be in the closing statement of the real estate transaction. And you might have to go to the closing statement to make sure that you're properly allocating and picking up the property taxes and who's basically paying for the property taxes. Once the sale has been made, then hopefully after the year of sale or purchase, whichever side of the transaction you're on, it should be fairly easy because then you're just going to be dealing with the property taxes. And you're going to be dealing with the mortgage, which includes the mortgage interest, most of which will be reported by the financial institution, at least the mortgage interest possibly even the property taxes. If you're paying it through them, otherwise you track the bills for the property taxes. So prepayments of next year's property taxes. So we noted when do you deduct things for income taxes, typically on a cashed based system when you pay them. So you might get the bright idea of, well, hey, look, I made more money this year than I'm going to make next year. Why don't I prepay the next five years of property tax this year, deduct it all this year when I'm in a higher tax bracket. And then next year when I'm in a lower tax bracket, that'll be work out for me for my taxes. But the IRS is going to be skeptical of that kind of things. The manipulation, that's why the cash based system, by the way, is not the preferred system used by corporations. They have auditors and audits and whatnot to make sure that people aren't manipulating the cutoff dates by manipulating cash flow, for example, because it distorts the financial statements, right? So same thing happens here. Cash basis is the easiest way to do it. That's what we're on. It's the easiest. We don't need audits or, you know, like a standard audit of financial statements to figure it out. It's simple to do. But you can come up with schemes like this of saying, well, I'm going to manipulate. When I pay the cash, manipulating the cutoff dates, and the IRS, of course, is going to try to come up with rules to stop that, right? So that's the idea. So only taxes paid in 2023 and assessed prior to 2024 can be deducted for 2023. State or local law determines whether and when a property tax is assessed, which is generally when the taxpayer becomes liable for the property tax imposed. So refunds and rebates. If you received a refund or rebate in 2023 of real estate taxes you paid in 2023, reduce your deduction by the amount of the refund or rebate. If you received a refund or rebate in 2023 of real estate taxes you paid in an earlier year, don't reduce your deduction by this amount. So we have a similar scenario as we saw with like a state tax refund, for example. However, this is one that does not come up as often because when you pay your real estate taxes it's unlikely that you're going to get a refund. That doesn't happen all the time as it does happen all the time with a state income tax system designed similar to a federal income tax system in which you overpay and will basically be expecting some kind of refund typically. But if you did get a refund because you overpaid the taxes for whatever reason, if it happened in the same year, then of course you would just reduce, you already know about it so you would reduce the amount of taxes you paid by the refund. If, however, you got a refund say in 2023, for real estate taxes you paid in 2022, the question as with the state tax refunds, same concept is did you get a benefit from the payment in 2022? If you itemized and deducted it, you got a tax benefit. So then you would think, well that means that I should just reduce the property taxes deduction I get to pay in 2023. But no, that's not how we do it because maybe you're in a situation where you didn't have property taxes in 2023 or something. Instead of adjusting your deductions you're going to include it in income. So if you got a benefit from it last year and then you got the refund back, you're not going to refund the prior, you're not going to amend prior year return, you're not going to adjust your deductions but rather the typical concept is you put it and include it in income in the current year. So that shouldn't happen like all the time but as it does happen all the time with the state income tax for example if someone is itemizing. So instead you must include the refund or rebate in income on schedule 1 form 1040 line 8Z if you deducted the real estate taxes in the earlier year and the deduction reduced your tax. So see recoveries in publication 525 for details on how to figure the amount to include in income.