Most everyone knows that regular annual property taxes are deductible for federal income tax purposes (ignoring AMT issues). However, what is often confusing to homeowners and tax preparers is the deductibility of certain extra one-time assessments used to fund public improvements (often called local benefit assessments).
For example, many homeowners that live in northern Fresno County live in an area referred to as County Service Area 51. CSA 51 was established to try to figure out if there was a viable way to bring city water to the low water areas of northern Fresno. CSA 51 ended up creating assessment district 283. Back in 2008 or so, the then residents of CSA 51 voted to have certain engineering plans drawn up to determine the feasibility of bringing water to that area--as part of this, it was agreed that the cost of such plans would be assessed to each parcel in the area (around $3,000 per house). Maps and plans were drawn up the final report indicated that it would cost each homeowner a whopping $50,000 or so to have water lines installed in the area. The CSA 51 residents then voted again in July of 2012 to see if the project (and the massive $50,000 per parcel assessment) would move forward. The measure ultimately failed.
The CSA 51 residents were left with engineering plans, a $3,000 per parcel assessment, but no water lines. Half of this $3,000 assessment (or around $1,500) recently showed up on homeowners' 2012-13 property tax bill (referred to as CSA ID 283), with the other half to be assessed next year.
The obvious question for the CSA 51 homeowners is "can I deduct this extra $1,500 in property taxes this year and again next?"
Unfortunately, the answer is NOT easy.
The deductibiliy of local benefit assessments really depends on the purpose of the assessment. Taxes assessed against local benefits of a kind tending to increase the value of the property are deductible as taxes only to the extent taxes are properly allocable to repairs, maintenance or interest charges. (Reg. 1.164-4(b).)
Thus, it has long been established that local assessments to build sewer or water lines, sidewalks, or irrigation lines benefiting a particular community, as opposed to the entire city or county, would be non-deductible. The idea is that these assessments benefited a select group of people and increased the values of their property.
However, the key fact in this case is that the project in CSA 51, never actually moved forward. Had the lines been built, there is no question that the initial $3,000 assessment and the additional $50,000 assessment would not have been deductible, but here, the operative question is whether or not the residents of CSA 51 have enjoyed some type of increase in value, simply by virtue of the fact that the county has had expensive engineering maps and plans drawn up.
Believe it or not, there is an old tax case from 1941 which addresses a similar situation (Thatcher v. Commissioner (1941) 45 BTA 64). In the Thatcher case a special assessment district was created to consider the installation of a sewer line in the neighborhood. After its creation, expenses were incurred for engineering services, attorney fees, and other expenses related to the planned sewer construction. As a result, general plans and maps were made, but the Court noted that there were no detailed plans for construction purposes. Shortly after, it was determined that the plan was misguided and the assessment district was disbanded. The question the court entertained was, what value did the residents get from these plans that had been drawn up. The residents claimed that because the construction was not moving forward, the plans held no value for future use and that they were simply paying for a "mistake in judgment". The IRS argued, however, that the plans and maps resulting from the expenditures had a value for future use and constituted a benefit to the residents.
The court ultimately relied on the fact that the construction project was not moving forward and stated as follows:
We do not agree with respondent's contention that the mere fact of the determination that the construction of a sewage system in the district was not feasible or too costly is a benefit. It may be a benefit to the present owner personally, in the sense that it will deter him from ever taking part in such a project again, but we can conceive of no reason for an increase in the value of the land by reason of a determination that it is not subject to sewage development except at a prohibitive cost. The natural effect of this, we think, is to decrease values.
In other words, when the city determined that it was too expensive to feasibly construct sewer lines, this would actually have decreased the values of the home. In short, the court decided that while there may be some value to having plans drawn up, if the plans actually show you that the end goal is prohibitively expensive and the project is ultimately dropped, there can be no "benefit" to the residents. The residents won and were allowed to deduct the assessments
With respect to the residents of CSA 51, there is no clear answer. While the facts and circumstances of CSA 51 are similar to the Thatcher case, they are not identical.