Author Topic: Pre-paying property taxes - huge risk-free rate of return? (U.S. federal taxes)  (Read 724 times)

Alaska13

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My situation is I have essentially zero deductions each year except my property taxes, which are roughly equal to the standard deduction for single individuals - $6,300. So based on that, I wouldn't itemize.

But I've read you can deduct property taxes in the year you pay them, not the year they are due (http://smallbusiness.chron.com/tax-advantages-paying-property-taxes-year-early-21437.html for reference), so I could pay 2 or 3 years of property taxes this year and be above the itemization threshold. My marginal tax rate is 33%, so by paying an additional $6,300 this year I would save a third ($2,100) of that in taxes. It seems equivalent to earning a $2,100, risk-free, after-tax return in return for making a one year loan (the loan in this case is paying the $6,300 a year before I would otherwise pay it).

First, is this line of thinking accurate? Second, how extreme can you go in this direction (i.e. can I pre-pay 5 or 10 years now? and wouldn't pre-paying now insulate me from the risk that the current tax reform proposal might strip away property tax deductions in future years?).

Thanks in advance to anyone who can help me better understand this situation.

secondcor521

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Generally, yes, your line of thinking is valid.  It is commonly done one year in advance where people itemize every other year by bunching deductions - usually property taxes and charitable contributions - to exceed the standard deduction in say, even-numbered years, and use the standard deductions in odd-numbered years.

I'd contact your local property tax authority to see how far in advance they will accept payments for.  I'd be surprised if they would accept it for more than about a year in advance.  For one thing, they don't know what your property taxes will be next year, and they are probably not set up to carry over a credit.  But they might be.

Usually if I think there is a way to make a risk free return, it means I haven't thought about the risks.  I will point out some risks you haven't mentioned.  Maybe you'll find them reasonable, maybe not.  Food for thought:

1.  Tying up that cash in prepaid property taxes means you can't use it for other investment opportunities that may come along in the next X years that you've prepaid.  These other opportunities may be even better.
2.  There is a chance that property taxes will continue to be deductible.  I agree with you this is small, but your prepayment strategy is making a bet that may not pay off.
3.  If you sell your house in the next few years, it increases the amount of cash your buyer has to bring to the table because they'll have to reimburse you for those prepaid property taxes.  That may be a disincentive to your buyer if they are cash strapped, and may make it harder for you to sell.
4.  Your local taxing district may respond to the changing tax climate by changing property taxes.  What if they get rid of property taxes and move to higher income taxes - will you get a refund?
5.  Depending on your tax situation, your itemized deductions may be reduced if you have a high income - see line 29 of Schedule A.  So it may not be as simple as multiplying your marginal rate by your deduction amount.

I don't mean to be a downer - it still might be a good idea for you - I just think it is good to carefully examine apparent "risk free" returns to make sure that it is likely to turn out the way you hope it will.
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Nate79

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My understanding is that you may deduct those property taxes that are imposed on you. It means you have to pay what you are actually billed for, not just send in a payment for some vague future amount. So this depends entirely on what you local taxing authority will do which may or may not allow payment one year in advance by billing you the appropriate amount.

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Bicycle_B

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What a great idea!