To the Boards of Directors of our Cooperative Housing Corporation Clients:
Federal Tax Legislation: Limitation of the Individual State, Local, Sales and Real Property Tax Deductions in 2018
As you may have been following, Congress has passed tax reform legislation that is expected to be enacted by this year end. One aspect that may warrant the Board’s attention is the specific provision which would limit the annual tax deduction for all state and local income, sales and real property taxes to no more than $10,000 ($5,000 for married individuals filing separately) beginning in 2018. An opportunity exists for shareholders of the cooperative to realize a one‐time benefit in 2017, should the cooperative “prepay”, in 2017, part of its 2018 real estate taxes due in January or January and April (if paid quarterly) 2018. The benefit would be that in lieu of four quarters of real estate taxes as a deduction in 2017, this one year there would be five or six quarters whereby deductions are amassed in the year that there is no limitation. However, there are numerous aspects which need to be considered. Please allow us to explain:
The cooperative would need to have sufficient operating cash available to fund the payment before the collection of some of the January maintenance payments by shareholders. Please realize that most cooperatives utilize the accrual basis of accounting and thus such a prepayment would normally have no effect. Having made an extra payment, a cooperative would, as part of filing its 2017 Corporate Income Tax Return, move to change its accounting method for income tax purposes to recognize all customary prepaid expenses (i.e., real estate taxes, insurance, possibly others) as deductions in the year paid as opposed to the specific period that they cover.
Please realize that while acceptance is expected, such a filing does require IRS approval. Further, the new accounting method must apply to all future years. Therefore, the cooperative will have to continue to prepay its same real estate tax obligation that is accelerated for each subsequent year going forward to ensure a full 12-month deduction is available to shareholders. The change of accounting method will result in differences between amounts reported in the cooperative’s income tax returns and its financial statements which use the Generally Accepted Accounting Principles method. There would be a need to maintain two sets of accounting records, one to support the income tax returns and the other to support the financial statements, commencing in 2017 and for each year moving forward.
To facilitate your decision whether to change the accounting method for income tax reporting purposes, we suggest that you consider:
- The IRS may not agree to the change in accounting method.
- Certain shareholders may not individually benefit from the prepayment of real estate taxes. There are many factors that could affect this including whether the shareholder is subject to the Alternative Minimum Tax in 2017.
- The cooperative will have to continue to prepay real estate taxes to provide shareholders with pass‐through real estate tax deductions based on 12 months of expenses as reported in the cooperative’s income tax returns.
- Should a successful challenge by the tax authorities to the tax position be taken, amended tax deduction letters and individual income tax returns might be required.
- There will be additional accounting fees incurred for the needed one-time filing of Form 3115 and to accomplish the necessary adjustments between 2017 and 2018 to support this change as well as for each year to maintain the two sets of accounting records previously mentioned.
Based on concerns outlined in the previous paragraphs, we do not recommend that our clients file a request for a change in accounting method. However, we are available to discuss each client’s circumstances with them. If a client does request so, we would do the additional work to change the accounting method and update the tax deduction letter. We do request that clients inform us immediately, or the latest by January 3, 2018 if they had chosen to prepay the 2018 real estate taxes and request the added work of us.
For those Boards which might not yet be ready to decide, the opportunity cost to make the real estate tax payment due in January 2018 by the end of 2017 is minimal, assuming sufficient cash is available, and the decision whether to change the accounting method can be delayed into early 2018.
As always, Czarnowski & Beer stands ready to provide the professional tax and accounting advice to enable our clients to fully achieve their goals. Please let us know if you have any questions on this matter.
Czarnowski & Beer, LLP.