Attention Irvine home owners: your Mello Roos are no longer tax deductible

What is a Mello Roos tax?

The Community Facilities District Act (more commonly known as Mello-Roos) was a law enacted by the California State Legislature in 1982. The name Mello-Roos comes from its co-authors, Senator Henry J. Mello (D-Watsonville) and Assemblyman Mike Roos (D-Los Angeles). The Act enabled “Community Facilities Districts” (CFDs) to be established by local government agencies as a means of obtaining community funding.

When California Proposition 13 passed in 1978, it restricted the ability of local governments to raise property taxes by more than an inflation factor. The budget for services and for the construction of public facilities therefore could not continue unabated. As a result, new ways to fund public improvements in respective locales were considered. The Mello-Roos fees are generally considered an end-run around Prop 13, which caps property taxes while Mello-Roos are not capped.

A Mello-Roos District is an area where a special property tax on real estate, in addition to the normal property tax, is imposed on those real property owners within a Community Facilities District. These districts seek public financing through the sale of bonds for the purpose of financing public improvements and services.These services may include streets, water, sewage and drainage, electricity, infrastructure, schools, parks and police protection to newly developing areas. The tax paid is used to make the payments of principal and interest on the bonds.

Mello-Roos is not tax deductible.

Irvine projects since 1982 have included Mello Roos taxes. Many of the newer communities have very high Mello Roos taxes. Although these taxes have never been income tax deductible, most claim the deduction anyway. The State of California is putting everyone on notice, you better stop taking this deduction.

Editorial: Bad news for many homeowners

State cracking down on income-tax deductions for Mello-Roos fees.

Published: Jan. 9, 2012 Updated: Jan. 10, 2012 3:25 p.m. — OC Register

Happy New Year. A tax many California property owners have not been paying now is going to be demanded of them by the Franchise Tax Board.

It concerns special assessments for vector control, mosquito abatement and water fees that almost everybody pays. But it mainly concerns property subject to Mello-Roos fees, special assessments created in 1982 to fund improvements and infrastructure in newer communities and which are not subject to Proposition 13’s limits on property taxes.

An example in a Jan. 9 article in the Register by Mary Ann Milbourn concerned a total property tax bill of $12,004 for 2011-12. Of that, the small fees amounted to $17. But the Mello-Roos fees were $4,776, or 40 percent of the total.

Until now, the Franchise Tax Board has allowed an entire property-tax bill, including the special assessments, to be deducted from state income tax. However, Ms. Milbourn reported, “Beginning with the 2012 tax bill (the one due in April 2013), the state Franchise Tax Board will require property owners to break down their property taxes into deductible and nondeductible portions.

“In Orange County, 181,550 of the county’s approximately 900,000 parcels were subject to Mello-Roos in the 2011-2012 tax year, according to the Auditor-Controller’s office. They were billed a total of $207.8 million.”

It will depend on the property owner’s state income-tax bracket, which tops out at 10.3 percent, but assuming an effective average rate of 6 percent, the additional tax on that $207.8 million would be another $12 million taken from Orange County taxpayers. Statewide, the total would be something like $140 million.

The bulk of that money will be coming from South County where there are more newer neighborhoods and particularly Irvine where Mello Roos taxes are quite high.

The FTB’s reasoning is that Mello-Roos and other fees never were exempted from the state income tax. Ms. Milbourn reported, “Until now the Franchise Tax Board didn’t to go after them. A new computer system being installed this year, however, will allow the agency to distinguish the portions of property tax bills that are deductible and nondeductible, said Daniel Tahara, a FTB spokesman.”

This will be a good investment for the State. They spent money on an upgrade which will now allow them to collect a tax they previously used to miss. 

Nothing doing, Jon Coupal told us; he’s president of the Howard Jarvis Taxpayers Association. “We need to clarify legislation before they do that,” he told us. “They ought to be thinking about reducing taxes, not increasing taxes. With as many upside-down homes as there are in California, you would think they would not make homeownership more expensive. It demonstrates the avarice of state government.”

That’s great rhetoric. California is desperate for cash, and squeezing a few extra bucks out of homeowners is either avarice or survival depending on your point of view. By making home ownership more expensive, they will ultimately make prices fall further.

Indeed, the Register’s Jonathan Lansner reported Jan. 8 that, for the 22 business days ending Dec. 20, the median selling price for a house in Orange County dropped 5.5 percent from the previous year. Condo prices were down 8.2 percent. And total residence sales were down 5.4 percent.

Because this new tax won’t have to be paid for 15 months, there’s plenty of time to rectify the situation. The FTB should reverse itself. If not, the California Legislature should clarify that the fees are deductible.

If those things don’t happen, there could be a court fight. “Taxpayers have a legitimate claim under existing law to make these deductions,” Mr. Coupal insisted.

No. These taxes were never tax deductible, and the Franchise tax board has issued clear rules on the subject.

As to court action, he said, “We would consider it. If they move forward, then we will consider legal options.”

Just two months ago, a unanimous California Supreme Court ruled, in a case concerning the county of Orange, that “an implied contract under California law” mandated that benefits to retired public employees could not be cut. How can that be different from an “implied contract under California law” involving a tax deduction taken by homeowners for three decades?

Or do public employees have more rights than taxpayers? We soon will find out.

Interesting argument. Since they never enforced the law, they now lose the right of enforcement. It will be interesting to see how the courts rule on that one. In the meantime, prepare yourself to pay more in state taxes as the Mello Roos deduction goes away.