Franchise Tax Board Implements Changes that Will Affect Millions of California Homeowners

A significant number of California property owners are about to discover that they must take a lower property tax deduction than what they may have claimed in previous years. This will take effect beginning with 2012 tax returns (that is, the returns that will be due in April of 2013).

Those who live in Mello-Roos districts (aka Community Facilities Districts or CFDs) are likely to be among the most dramatically affected, as fees frequently run into the thousands of dollars in these areas.

Traditionally, Mello-Roos fees have been seen as a deterrent to sales of homes within such districts.  In more than a few cases, sales agents and sellers have sought to offset this by emphasizing that the fees were tax deductible.  However, legally that never was true. It is true that, for years, many property owners have deducted the fees without being challenged by the taxing authorities.  But no longer.

Earlier this year the Franchise Tax Board (FTB) announced that the installation of a new computer system will allow the agency to distinguish between those parts of the property tax bill that are deductible from those that are not.  According to FTB spokesman Daniel Tahara, creating this system was not the result of any particular pressure to increase tax revenues, “Every year we look at areas of non-compliance and this happened to be one that came up,” he said.

Practically every tax-paying property owner will be affected by the new reporting requirements, not just those in Mello-Roos districts.  This is because most taxpayers simply deduct the total amount indicated on their property tax bill.  Few realize or think about the fact that the total is generally a composite of both deductible and non-deductible charges.

According to the FTB: “You cannot deduct any amounts shown on your property tax bill, including special assessments, special taxes, fees, or charges that are not computed based on the assessed value of your property, regardless of their purpose.” [my emphasis]  Taxes based on the value of the property are known as ad valorem taxes.  Generally, these are deductible.  The bill will indicate their tax rate, expressed as a percentage or a decimal.

Generally non-deductible are those fees (e.g. for vector control, a 1915 Assessment District Bond, or a CFD) that are a fixed rate and not based on the property’s value.  Of course, there are some exceptions to these rules. 

Beginning with next year’s California returns, the FTB will require property owners to separate their property taxes into those that are deductible and non-deductible.  There has been no indication that the Federal form will require such a breakdown.  Nonetheless, inasmuch as California law conforms to Federal law in this matter, the amount deducted should be the same for each.

The Franchise Tax Board web site has a section that explains the details.  It includes a portion that allows one to look at a sample tax bill for each county.  They don’t all use the same format.  On the sample it shows which charges are deductible and which are not. 

It has been estimated that, as a result of the new program, as many as 5 million Californians will see a major cut in their property tax deduction when they file next year.