How Are Real Estate Taxes Calculated?
Real Property Taxes:
Tax rates on real property:
It’s really quite simple - real property tax rates are computed by applying the tax rate of the county to the assessed valuation of the property. The assessment is made yearly and comes in the form of an annual property tax statement. Once real property is assessed there are due dates assigned for payment (which in most U.S. counties is twice per year).
Governments are empowered to assess and collect taxes through their right to levy taxes. Like everything else related to taxes, there is usually a penalty in place for payments that are not paid by the penalty date and the penalties for late property taxes can be substantial depending on the governing taxing authority.
Real property taxes are not the only taxation that can apply to real estate. Income taxes can also apply to those of us who are income producing land developers or builders, also capital gains and excise tax can apply on a sale - but our focus today is limited to non-transactional tax on the real property itself.
Real property tax rates:
First you have to start with a budget from the taxing body, usually for the next 12 month period. The budget includes the estimated expenditures for the year. After that we have the appropriation stage where the taxing authority authorizes the expenditures and lawfully allocates them. The allocated tax is then imposed on real property owners by a tax levy.
The total monies needed from property taxes is divided by the total assessments of real property within the jurisdiction of the taxing authority. Boom - you have your tax rate! Note - it’s not the number of individual properties that is divided; it is the total dollar assessment per property. Therefore, properties assessed at greater dollar value pay more. In theory every property owner pays at the same tax rate within each property tax classification.
How property taxes are calculated:
It varies by the county or township taxing authority, but here is what is typical:
Let’s say $500,000 is needed to be raised from real property taxes for a given assessment and the total taxable real estate in the tax jurisdiction is 15 million. The equation would be - $500,000 / $10,000,000 = 0.05 (or 5%).
How tax bills are calculated:
General property taxes:
General property taxes are called ad valorem, which is latin for “to value”. This is the real property tax that most real property owners think about. The one where you get a notice statement about the proposed taxes and eventually your property tax bill. The final computation of the tax bill is partially determined by what is approved by voters on upcoming levies, like schools. Also computed are the support and operating costs of government agencies that provide public services to the property; one example being emergency services.
Exemptions to general property taxes:
Governments don’t tax themselves. Therefore, property owned by federal, state, county or municipal governments are exempt from real property taxation and there can be exemptions for other qualifying entities and certain other qualifying uses.
Special assessments:
Real property is subject to special assessments from taxing agencies. A Local Improvement District (L.I.D.) is an example of a special assessment. An example would be when a sewer main is extended outward from point A to point B, past properties currently on individual septic service. For the homes between the two points a charge is levied and recorded against the properties until they pay to hook up to the sewer line. The L.I.D. cost could be substantial for each homeowner, so a L.I.D. like the one described above might give the property owners an extended time to hook up to the new sewer line, thus taking some of the bite out of having to pay right away. One example I know from quite some time ago would cost each homeowner about $10,000 for the sewer hook up.
Investors and developers should be careful during acquisition to determine if there are actual or proposed L.I.D.’s on a subject property.
Enforcement:
Each taxing authority has enforcement powers. With real property it starts with late payment penalties, followed by strict collection procedures where ample notice is given to the property owner to make good. The final measure, which takes time and is carefully regulated, can be a tax sale of the property, thus displacing the homeowner.
Property designation and tax:
Residential, forestry and agriculture are three examples of different designations that can affect tax. The concept is that properties vary in economic use and value. A decent example would be 100 acres zoned high density in downtown Tampa should be designated differently than 100 acres used for an orange grove within the same county.
One very smart investor I knew was famous for buying up low priced land in the forestry tax designation, harvesting merchantable timber with a conversion option permit, then subdividing into residential lots. He had to pay to pull the lots out of forestry and into the residential designation to get permitted, but it sure penciled out nicely!
Personal exemptions:
If allowed, certain groups can get relief on their property taxes. The most well known examples are the senior and disabled citizen property tax exemptions. I am not sure why they call them exemptions since qualifying owners are not really exempt from property taxes, they are just charged a different rate. Senior discounts used to be a no-brainer if you were at or beyond the qualifying age, but not anymore since taxing authorities have gotten more crafty. Now many counties also tie in gross income limits. One county in my home state has three levels of discounted senior citizen taxation based on annual gross income. Seniors can use some deductions, like medical expenses to reduce the gross, but even with the adjustments the maximum you can make is $45,708 per year to qualify. In other words, a lot of senior citizens can no longer qualify based on their income being too high … anything to collect a buck…
Business exemptions:
States, counties and cities compete with each other to attract business investment in their respective economic zones. Sometimes this results in tax discounts across the board, to include property taxes. The rationale is that business investment attracts jobs and jobs produce income spent locally or regionally. That produces tax, especially in the form of sales tax, typically the largest revenue producer for local government. It’s amazing what some authorities will offer to attract big business while sticking a pin in the rear end of seniors as described above.
For land developers:
A clever land developer can look at different designated tax programs as a way to acquire property at lower prices than buying in a higher tax designation. This can be especially true if there is revenue opportunity (like merchantable timber) that can be captured quickly as previously mentioned. Extreme care must be taken to ensure that conversion to the higher end use is possible and that none of the pre-conversion activities would prevent the intended future use.
Developers often look at properties near proposed utility main extensions. Smart investors with experience in acquisition take care to research any current or proposed L.I.D.’s or other special assessments, along with the associated costs involved. Good luck!
