Deductibility of Mello-Roos and Other Tax-related Assessments in California
Historically, the Franchise Tax Board (“FTB”) has not often audited property tax deductions claimed on taxpayers’ returns. The recent December 2011 release of the FTB’s Legal Division Guidance on Real Property Tax Deductions, however, shows that the FTB has taken an interest in this issue and may indicate that the FTB will begin looking more closely at property tax deductions on California state income tax returns starting in 2012.
Although the FTB acknowledges that California conforms to federal law regarding these deductions, the FTB’s new interpretation is not one that the Internal Revenue Service (“IRS”) has previously followed. Specifically, the FTB states that the only real property taxes subject to an itemized deduction are those that are assessed on the basis of the value of property, i.e. ad valorem. In a 2003 Memorandum, however, the IRS found that assessments may be deductible as real property taxes even though they are not imposed on an ad valorem basis.
The FTB also takes the position that taxpayers may not deduct assessments (whether assessed on an ad valorem basis or otherwise) for local benefits (such as improvements to streets, sidewalks, etc.) of a kind that tend to increase the value of the property and are imposed because of, and measured by, some benefit coming directly to the property against which the assessment is levied. Such payments often come in different forms, but the FTB currently has focused on Mello-Roos assessments. Mello-Roos assessments can be used by cities, counties, and special districts (such as school districts) to finance major improvements and services within an area including, but not limited to, schools, roads, libraries, police and fire protection services, and ambulance services.
A portion of such assessments for local benefits may be deductible if they are made for the purpose of maintenance or repair, or for the purpose of meeting interest charges with respect to those local benefits. The burden is on the taxpayer, however, to show that a portion of the amount assessed is allocable to these purposes and should be deductible.
The FTB’s approach to Mello-Roos may change with the enactment of a newly proposed law in Assembly Bill 1552. Assembly Bill 1552 was introduced on January 26, 2012 and, if passed, would make Mello-Roos fees tax deductible for each taxable year on or after January 1, 2012. This law would thus allow Californians to continue to benefit from the facilities and services provided as a result of Mello-Roos payments, while also being able to deduct these payments in the future. For now, however, taxpayers should acquaint themselves with the FTB’s position focusing on the propriety of certain property tax deductions.
If you have any questions regarding the contents of this newsletter, please contact the following attorneys in the firm’s State and Local Tax Practice Group.
| Chicago (312) 558-5600 | San Francisco (415) 591-1000 |
| Robert F. Denvir | Charles J. Moll III |
| Alan Lindquist | Troy M. Van Dongen |
| Bradley R. Marsh | |
| Jocelyn M. Wang | |
| Dina Bronshtein Segal | |
| Jasmine I. Tollette |