Tax planning to maximize real estate tax deductions.

• Author: Steinsaltz, Michael E.

In early 1992, the IRS published Rev. Proc. 92-28 related to the implementation of Sec. 461. This revenue procedure will require each taxpayer to determine which method of accounting it will use to deduct real estate taxes for tax years beginning after Dec. 31, 1991. For calendar-year taxpayers, this analysis will have to be made in order to properly file a 1992 tax return. Since real estate taxes represent significant tax deductions, the choice of method may provide a valuable tax planning opportunity.

Overview of allowable methods

There are three methods that a taxpayer may use to deduct real estate taxes on its 1992 tax return: 1. The payment method. 2. The payment method with the recurring item exception. 3. The ratable accrual method. Both forms of the payment method are governed by Sec. 461(h). A taxpayer who does not affirmatively elect the ratable accrual method described in Sec. 461(c) will be governed by one of the two payment methods under Sec. 461(h).

In general, Sec. 461(h)(1) states that an expense is deductible by an accrual-basis taxpayer in the tax year in which it meets three tests:

1. As of the end of the tax year, all of the events must have occurred that determined the fact of a liability (the liability must be fixed).

2. As of the end of the tax year, the amount of the liability must be determinable with reasonable accuracy (the liability must be determinable).

3. As of the end of the tax year, economic performance must have (or be deemed to have) occurred. With regard to real estate taxes, the proposed regulations under Sec. 461 (which become effective for all tax years beginning after Dec. 31, 1991) state that economic performance occurs when payment is made.

The first two tests together are known as the all-events test; the third test is known as the economic performance test.

In certain circumstances, a taxpayer that is not a tax shelter can avoid the restrictive economic performance test in determining the timing of a deduction by electing the recurring item exception. If the recurring item exception is elected, the economic performance test will be deemed to occur as of the close of the tax year, if the all-events test is satisfied, the accrued liability is paid by the earlier of 81/2 months after the close of the tax year or the date on which the tax return for the year in question is filed and certain other requirements of Sec. 461(h)(3) are met. It should be noted that the Sec. 461 regulations deem real estate...