How Do Real Estate Property Taxes Work

Taxes are essential for funding public programs and services. While most people in the United States are familiar with federal and state income taxes, those who haven’t owned real estate or a business may be less familiar with how real estate property taxes work.

In ancient Europe, property taxes were initially based on the size of the land. Generally, the larger the land, the higher the real estate property tax. However, over time, the value of land began to be assessed based on its capacity to produce goods and services. Hence, generating profit for the owner.

Tax assessors started to evaluate additional property on the land, such as structures, farming equipment, and livestock. For instance, if Lord Garish owned 1,000 cows, 3 stables housing 30 horses, and a castle on a small piece of land, he would have to pay more in property taxes than Lord Frugal, who had only 13 cows on a large piece of land.

In the American colonies (which became the United States), local governments implemented a “general property tax” that required colonists to pay taxes on all property, whether real estate or personal.

Today, property taxes in the United States primarily focus on real property. For example, office buildings are typically taxed based on the rental income they generate for their owners.

In the following sections, we will explore how governments utilize real estate property taxes, the methods assessors use to calculate tax bills, and how these tax bills can change over time.

Real Estate Property Tax Assessments:

In the United States, local governments rely heavily on revenue from real estate property taxes to fund essential public services. Some of these services include fire protection, law enforcement, road maintenance, and schools.

Do you know?… Property tax revenue accounts for about half of the revenue raised by local governments. Without this revenue, local governments would struggle to provide these critical services. Taxable property includes any real estate not owned by the government, such as houses and businesses with physical locations.

However, religious organizations, like churches, are usually exempted from property taxes. Despite this exemption, tax assessors still assess the value of government-owned properties as well as exempted church properties.

Property Tax Assessment:

A property tax assessment is the determination of the market value of a property. A tax assessor, who is either an elected or appointed official, is responsible for assessing the value of every taxable property within an assessment area.

Assessing the value of every property individually would be an enormous task for the assessor. Fortunately, the process is more straightforward. Hence, assessments are made by comparing the market value of similar properties.

For instance, if Mr. MacDonald sells his farm at a price close to his asking price, the tax assessor can use that sale price as a basis for assessing the property tax values of farms similar to Mr. MacDonald’s. Nonetheless, each local government has its own procedures for real estate property tax assessments.

Generally, when setting or adjusting a tax rate, local governments consider the amount of money generated from various revenue sources. This amount is then compared to the government’s annual budget. The difference between the budget and the expected revenue is often referred to as the tax levy.

For example, if the Rose City government has a $6 million budget and receives $3.5 million in sales tax revenue and state aid, the city needs to raise an additional $2.5 million through property taxes to meet its budget:

$6,000,000 – $3,500,000 = $2,500,000

Purpose of Modern Property Tax:

The fundamental purpose of the modern property tax is to provide revenue for public services. Consequently, real estate property tax rates vary widely across the United States based on the needs of individual local governments.

One city might use property tax revenue to repair roads filled with potholes. On the other hand, another might use the funds to hire more police officers to combat a gang problem. Interestingly, real estate property tax rates do not change significantly over time.

Instead, governments are more likely to adjust the rate at which properties are assessed. This is known as the assessment rate or assessment level. However, there are other factors that can also affect a real estate property tax bill.

Unfair Assessments:

Property assessments are not always accurate. For example, while Mr. Terry’s farm and Mrs. John’s farm may have the same number of barns, Mrs. John’s unused, dilapidated barns are worth less than Mr. Terry’s.

If Mrs. John feels her property has been overvalued, she can appeal the assessment with her local assessor. This option is available to anyone who is concerned about their property tax assessment.

What Makes Real Estate Property Tax Bills Change:

As previously mentioned, the actual property tax rate rarely changes. Instead, if a government needs to generate more revenue through real estate property taxes, it is more likely to increase the assessment value of properties. This increase in assessment value leads to a higher taxable value for your property.

When this higher taxable value is multiplied by the unchanged property tax rate, it results in a larger tax bill. Several factors can cause your tax bill to change. Real estate typically appreciates over time, so property tax assessors usually reassess the value of real estate every few years.

For instance, in Illinois, county tax assessors reassess properties every 4 years. On the other, Cook County reassesses properties every 3 years. When real estate values increase, the first number in the property tax equation rises, leading to a higher tax bill.

To prevent excessive property taxes as real estate values soar, governments might adjust the assessment or tax rate. Conversely, a decrease in real estate value, possibly due to natural phenomena/disasters, would lower the tax bill.

However, if a local government cannot afford to lose the revenue generated by real estate property taxes, it might raise the assessment rate or even the property tax rate. Furthermore, the arrival of new businesses in a community can also impact your tax bill.

These businesses generate income, and when new houses are built on previously undeveloped land, property values rise. In such cases, your tax bill could actually decrease, as the property tax burden is spread across more properties.

What’s More?…

Changes in a government’s budget can also lead to increases or decreases in your tax bill. For example, if your town government plans to build a new high school, the budget might increase.

If the government cannot secure funding from other sources, a change in the property tax calculation could raise your tax bill. Conversely, a smaller budget could result in a lower bill.

Local governments often generate substantial revenue from sales taxes. If your town hosts a popular event, such as the Rose City Festival of Toys and Miniatures, and tourism brings in significant revenue, your town’s budget may benefit from this influx.

However, if attendance at the festival declines over several years, local authorities might seek alternative revenue sources to cover the shortfall. This will potentially lead to an increase in real estate property taxes.

While a healthy local government budget is beneficial, it’s essential to consider your own budget as well. In areas with large cities, property tax assessments work a bit differently.

For instance, the tax or assessment rate in places like New York and Chicago is not uniform for all properties in the county. Instead, properties are classified by type, such as residential, industrial, and commercial, with each class having its own tax and/or assessment rate.

How Real Estate Property Taxes Affect Income Taxes:

After paying significant amounts in real estate property taxes, it’s nice to know you can get some relief when tax season rolls around. On April 15, as you calculate your personal income tax, you can often deduct the real estate property taxes you’ve paid.

In most cases, you are allowed to deduct the real estate property taxes you pay at the state, local, and even foreign levels. These taxes are deductible from your income tax as long as they meet the following criteria:

The taxes contribute to the general public welfare.
The taxes are based on your property’s assessed value.
All properties within the assessment area are taxed at the same rate.

However, there are exceptions to what you can deduct. You cannot deduct taxes that directly increase the value of your property or that are charged for local benefits, such as sidewalks and sewer lines. On the bright side, while these taxes may not be deductible, you may be able to add them to your property’s cost basis.

Additionally, some local benefits, especially those related to maintenance and repair, are deductible. If you’re unsure whether a specific property tax is deductible, the IRS provides resources such as Tax Topic 503, “Deductible Taxes,” and Publication 530, “Tax Information for First-Time Home Owners,” for guidance.

Real Estate Property tax Deduction:

To deduct your real estate property taxes from your personal income taxes, you’ll need to file a 1040 long form along with Schedule A. Be sure to check whether the standard deduction might be more beneficial for your situation. You can also consider consulting with a licensed tax professional.

If you own a second home, you can also benefit from tax breaks. You can deduct both your mortgage interest and property taxes on the second home, provided you itemize your deductions. The property taxes on your second home must meet the same requirements as those on your primary residence.

Is Your Home the Mother of All Tax Shelters?

Generally, the tax benefits available to homeowners are an excellent way to save money. You can deduct the interest and property taxes you pay on your primary residence as well as any additional homes you may own. Additionally, you may be able to deduct the interest paid on any home equity lines of credit associated with your properties.

Property Taxes FAQ:

Why do we pay property tax?

Property taxes generate the revenue that local governments use to fund essential public programs and services, such as fire protection, law enforcement, road maintenance, snow removal, public parks, and schools.

How do you pay your property taxes?

There are typically two methods to pay your property taxes: they can either be included in your monthly mortgage payment or paid directly to your local tax office. If you choose to pay directly, you should receive a bill detailing the amount owed and the various payment options available.

Can you pay your property taxes online?

The acceptance of online payments depends on your local tax office, but most offices offer an online payment option. Additionally, you can often pay by check, money order, or over the phone using a credit or debit card.

How do I find my property tax history?

Property-related documents, including tax records, are public records. You can view them by visiting your local county assessor or auditor’s office, where you can make an official request to access the property tax records for a specific property.

How do I find the tax-assessed value of my home?

The tax-assessed value of any home is public information and can be accessed by anyone interested. This information is typically available through your local county assessor or auditor’s office, and many offices provide this information online on their websites.