A city, county or other government agency assesses a local service tax to pay for the cost of building and maintaining infrastructure, such as streetlights, roads and the sewer system. It may also assess a tax to provide a service to residents, such as trash collection or tree trimming. Local service taxes that add a valuable improvement to the property or provide a service are not deductible, but the taxpayer may be able to deduct interest charges and repair fees.
The local government has to split up the charges on the bill to make a portion of the local service tax deductible. The bill has to specifically state that the fee is an interest or maintenance charge and the taxpayer may not estimate these portions. Many local governments do itemize their bills, because they know that their residents can claim this local services tax deduction that acts as a federal subsidy for the community.
The intent of the rule is to prevent a property owner from claiming a tax deduction when the local government pays for improvements that make the property more valuable, according to the Congressional Budget Office. Installing a new streetlight increases the value of the property, but fixing a broken streetlight or making an interest payment to pay for fixing the streetlight in a previous year does not make the real estate more valuable.
Special Taxing District
If the real estate owner lives in a special taxing district, a local service tax deduction to pay off the special taxing district's old debt, including principal, is available. To qualify, the special taxing district has to charge each real estate owner a percentage of the value of the real estate each year, including improvements that the taxing district paid to install. The district must include an entire county, and at least 1000 real estate owners must have the responsibility to pay the property tax.
When the local government installs nondeductible improvements such as a new sidewalk on the property, these improvements can increase the tax basis of the property. The real estate owner capitalizes these improvements and has to recognize a larger profit on the sale of the property on a federal income tax return. Deductible local service charges will not affect the tax basis and increase the taxable gain on a sale, even if the property value increases after the government performs regular maintenance.