Understanding Property Taxes

What are property taxes?

The city, town, or county in which you live operates the school system, provides police and fire protection, and repairs the streets–in short, it maintains the community infrastructure and provides services the residents enjoy. Doing this takes money, which the local governing authority raises (in part) through collecting real estate taxes, or property taxes.

How property taxes are determined

Your property tax bill is based on two factors: the property tax rate and the assessed value of your home.

The tax rate

Put simply, a local governing authority’s property tax rate will be the annual operating budget of the authority, divided by the assessed value of all the taxable real estate within its geographical boundaries. (Some property, such as that owned by churches, colleges, or the governing body itself, is not taxable.) This rate is expressed as a dollar amount per $1,000 of taxable assessed value.

Example(s): A town with an annual budget of $3 million and a total taxable real estate assessment of $60 million would have a tax rate of $50 for each $1,000 of taxable assessed value ([$3,000,000/$60,000,000] x $1,000 = $50).

In an effort to curb tax increases and to make local governing bodies more fiscally responsible, popular referendum ballots in many states have limited budget increases based on the collection of property taxes. For example, a budget may be limited to 1 percent of the market value of the property within the municipality.

The assessed value of your home

The other factor that determines your property tax bill is the governing body’s assessment of your home value. This assessed value is usually a percentage of either your home’s fair market value (FMV) or its replacement value (the cost of labor and materials to replace the home, less accrued depreciation). This percentage valuation may not be 100 percent of your home’s FMV, however. As a result, your home’s assessed value may differ from the price at which you bought it or could sell it. Whatever the percentage value used, it’s generally applied uniformly within a particular class of property (commercial, industrial, or residential) to avoid inequitable assessments.

Example(s): Your home’s FMV is $180,000, and your town assesses real estate at 23 percent of FMV. Your home’s assessed value, then, is $41,400. If the town’s tax rate is $50 per $1,000, your annual property tax bill will be $2,070 ($50 x 41.4), or $172.50 per month.

Caution: Many home assessments are based on outdated appraisals. In most cases, this means the property is assessed for far less than it is worth on the market. A home sale may trigger a reassessment for property tax purposes, and your tax bill may then increase.

Appealing your assessment

If you think your property tax assessment is incorrect, you may appeal it. There can be many reasons to do so:

  • A newly constructed high-rise across the street has deprived you of your view
  • The new commuter station has increased traffic in your neighborhood
  • Recent commercial development has increased noise, odors, and pollution
  • The house has developed structural flaws that may not be repairable
  • Pest control has become a problem

Most property assessments are not based on individual inspections of the properties themselves. In many cases, these assessments may be based on large-scale appraisals done by third parties contracted to conduct them, and may have rolled over data from previous assessments. This process can perpetuate old valuations. As a result, getting your assessment changed may largely be a matter of doing a better job of appraising the property than the local assessment office did.

Tip: If you do want to appeal your assessment, you must act promptly, since the filing period is often limited.

Property taxes vary, depending on location

Property taxes can vary dramatically from one locale to another. Therefore, the local property tax rate should be one of the factors you consider when deciding to buy a home.

Example(s): Assume Town A levies taxes at the rate of $14 per $1,000 of assessed value. Town B levies taxes at the rate of $30 per $1,000 of assessed value. If you buy a home in Town A that is assessed at $200,000, you’ll pay $2,800 per year in taxes (or $233.33 per month). If you buy a home in Town B that is assessed at $200,000, you’ll pay $6,000 per year in taxes (or $500 per month).

Along with the tax rate, you’ll want to consider the types of community services that are supported by the property taxes. In some cases, higher property taxes may mean more extensive services. The local property tax assessor’s office can provide you with information about current property taxes in the area, as well as the allocation of property tax funds, the rate of property tax escalation, and the frequency of property tax increases.

Paying property taxes

Property tax statements will be mailed to you from your local tax assessor’s office. These statements generally contain a breakdown of your tax obligations, along with a description of how the tax was calculated, the assessed value of the property, a legal description of the property itself, the amount due, and the due date of the taxes you owe.

Taxes are usually payable quarterly or twice a year. If your mortgage lender requires you to escrow taxes, though, you’ll pay several months’ worth of taxes to your lender upfront when you buy your home. Thereafter, your mortgage payment will include one-twelfth of the annual taxes. Many lenders use a tax service that notifies them of property tax bills that are issued (you will generally pay a fee for this service when you finalize your mortgage loan). If your lender does not receive notice of your tax bills, mail any tax bills you receive to your lender, and your tax bill will be paid from your escrow account.

Tip: A homebuyer is responsible for real estate taxes from the date of sale forward. At the closing, the buyer and the seller divide the real estate taxes, with the seller paying taxes up to (but not including) the date of closing. If the seller has already paid a tax bill for a period extending beyond the closing date, the buyer will reimburse the seller at closing for that extra portion.

Deducting property taxes on your income tax return

If you itemize your deductions on Schedule A of your federal income tax return, you may be able to deduct the property taxes you paid during the year. To be deductible, the taxes must be based on the assessed value of the real property and be charged uniformly against all property under the jurisdiction of the taxing authority.

Tip: Deductible real estate taxes generally don’t include fees charged for local benefits and improvements (“betterments”) that increase the value of the property, such as the installation of a town sewer line to the property.

Tip: Payments you make to an escrow account generally aren’t deductible until your lender actually pays the taxing authority.

Caution: A real estate tax can only be deducted by the owner of the property upon which the tax is imposed. For example, if your mother holds title to a house and you pay the taxes for her, you won’t be entitled to claim a deduction for the taxes paid.

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