Financial Planning for Los Angeles Residents: Dealing with the SALT Tax Limitation

los angeles financial planning SALT limitation

 

As part of the Trump federal income tax changes, a $10,000 limitation was placed on the amount of state and local taxes (“SALT,” for short) you can deduct on your federal tax return.  Initially there was a rush of activity by high-tax states looking for potential workarounds.  Unfortunately most of those strategies have not panned out, so it appears that for now that the SALT tax limitation is here to stay.

 Significant Tax Law Change

If you live in Los Angeles, and especially if you also own a home here, this impacts you. Why? Because California has high state income tax rates. And depending on how long you have owned your home, you may also pay high property taxes. With the new $10,000 per year cap on SALT deductions, if you pay more than $10,000 in these taxes combined, you’re probably going to notice a higher tax bill in the coming years.

Given this reality, as financial planners, we always recommend people look at their situation sooner rather than later to see if there are any steps you can take to mitigate the impact.

Background

Before the tax changes, individuals who itemized deductions were allowed to deduct state and local income taxes and property taxes without limitation. The tax code was quite flexible, too, and included property taxes on vacation homes and homes owned internationally, as well.

Under the Tax Cuts and Jobs Act of 2017 (TCJA), this amount now has been capped at $10,000 per year. Additionally, property taxes on personal foreign real estate can no longer be deducted at all.

Who Will Feel This Most?

Obviously, those who pay a lot more than $10,000 in state income tax and property taxes will feel the biggest pinch. For Los Angeles residents, this means:

  • High-income earners, since California has high state income tax rates
  • Those who live in homes with high property tax bills
  • Those who own a vacation home

Los Angeles Homeowners Will More Likely Be Impacted

Because of the high tax rates for California, many people will be impacted. In Los Angeles, you’ve got a double whammy with high housing prices, too.

If you’re a more recent buyer of a home, you’re likely to feel the impact.  That’s because the property tax is based on the price you paid for the home (per Proposition 13).  While this is a good thing for people who bought decades ago, those who bought during times of higher home prices have high property tax bills to contend with.

Actions to Take or Consider

Enough about the problem—that’s here, and it’s probably not going away.

The relevant question to you is: What can you do about it?

Unfortunately, there are no easy fixes, but there are some things you can do, or at least consider. They are listed from easiest to hardest.

(1)  Review your property tax bills for errors.

Especially if you’re a more recent buyer, Los Angeles property taxes can be very expensive. Therefore, always take the time to review tax bills. Administrative errors can and do happen, and property tax bills are frequently amended to correct problems. In Los Angeles, there are often many additional special assessments on the tax bill, and each is calculated separately, so the possibility of an error compounds. If anything looks out of line, call the number on the property tax bill next to that line item, or search the internet for details on how that number is calculated. If you’ve got any particularly large line items on there (such as bonded assessments or Mello-Roos special taxes), you may want to contact the administrator and ask them to send you the official documentation showing how the charge is calculated each year. Sometimes, these are based on square footage of the home or size of the lot, for example, which may be incorrect on a particular source they rely on.  The higher the charge, the more worth your while it is to verify that it’s correct, obviously.

(2)  If your property value has dropped, apply for a Decline in Value adjustment.

Although sometimes it may not seem like it, property in Los Angeles can fall in value. In cases of down market cycles, your property may fall in value from year to year, but Proposition 13 allows the majority of your tax bill to continue to increase by 2% per year. If so, you might be faced with a situation where you believe your property is worth less than the current assessed value. If so, it may be worth your time to file a request for reassessment, which can result in a lower tax bill. Learn more about that process here.

(3)  Consider a non-grantor trust for property.

If the amounts justify it, a non-grantor trust might allow you to shift your residence and property tax payments to a trust that gets its own $10,000 SALT limitation. You can also use multiple trusts to get even more SALT deductions for a single property. However, these must be cost-effective and require careful analysis and the help of experts to set up and administer.

(4)  Consider a move to a low-tax state.

If you have the flexibility, it may be time to consider a move to a state that has lower income and property taxes. People have historically done this when the pain has been great enough. Because California residents have both a high state tax and usually high property taxes, the benefit can be quite significant.

Conclusion

If you’ve been paying high state income taxes and/or high property taxes, the new SALT limitation is likely going to hurt you. These ideas may serve to soften or even eliminate that increase.  Some are harder than the others to implement, and may or may not be worth the cost or effort, but that’s where financial planning comes in: to help you decide what makes the most sense for you.

 

 

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