When you own rental property, almost all your expenses are tax-deductible. Fines and penalties are not included in the "almost." The IRS says that with a few exceptions, government penalties are never a write-off. Even though property taxes are a valid deduction, late fees and interest on your tax bill are not.
Even though the penalties aren't deductible, some of your related expenses may be. Most counties have an appeals process for you to challenge property-tax assessments. Any money you spend on appeals or defending yourself in court is a legitimate business write-off. That includes not only legal advice and services but court costs or the cost of copying government documents. Keep records of your costs and you can deduct them from your rental income.
Although you can't deduct penalties and interest, the back taxes themselves are still a write-off. The exceptions are taxes imposed to pay for improvements in the neighborhood, such as sidewalks or street lights. Unlike taxes based on the value of your rental, they're not deductible. For those taxes that are a valid write-off, you only get to write them off for the year you actually pay them. If you pay last year's property taxes this year, you take the deduction this year, even if you needed it more last year.
Although you can't write off special tax assessments for improvements, you can use them to cut the taxes when you sell the house. If you pay $5,000 in current and back assessments this year, say, you subtract that from your capital gains when you sell the house. That reduces your taxable gain. Another delayed deduction happens if you run in the red and can't write off all your court costs or other expenses. Instead, you can carry them forward to next year and write them off against next year's rental income.
If you owe back taxes and penalties on your personal home, the same rules apply: taxes are deductible, penalties aren't. Property tax, however, is only deductible on your home if you itemize deductions on Schedule A. With a standard deduction, there's no write-off for the tax. Just like a rental, you can't write off the cost of special tax assessments, but you can factor them in when you figure your capital gains on selling the house.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.