To understand real estate taxes, you need to understand ad valorem taxes. Ad valorem is Latin for “according to value.” And ad valorem taxes are a series of taxes levied based on the value of an item.
The government knows you want to buy stuff, and they want to tax the things you buy. So they’ve enacted ad valorem taxes. In the United States, sales tax is an example of an ad valorem tax.
If you go to Home Depot and fill up your basket, you’ll have to pay sales tax on the amount of money those items add up to. My local sales tax is 8.25%. So, if I buy $100 worth of goods, I’ll have to pay $108.25 in total for them.
But sales tax isn’t the only ad valorem tax there is. In the following few sections, we will discuss real estate tax, property tax, and personal property tax.
Note: We are not a law or accounting firm, and I am not an attorney or a certified tax representative. The information contained in this article is general information and should not be considered legal or tax advice.
What are Real Estate Taxes
Real estate taxes are the taxes you pay annually for the properties you own. These taxes are based on fair market value which encompasses land, buildings, and permanent improvements.
State and Local Government Taxes on Property Owners
Generally, the federal government doesn’t charge ad valorem taxes. And when it comes to real estate taxes, the state government typically isn’t involved. Instead, real estate taxes fall under local jurisdictions.
These jurisdictions can overlap and include parishes, counties, cities, towns, utility districts, school districts, and special taxing authorities. It varies widely on how these taxes are administered and which authorities get a piece of the pie.
Are Real Estate Taxes and Property Taxes Different?
The terms real estate tax and property tax have been used interchangeably. However, if you run into the term personal property tax, you need to know that this is something different.
Personal Property Taxes vs. Real Estate Property Taxes
As we discussed earlier, real estate tax is the tax levied on your owned real estate. Personal property taxes are an ad valorem tax on real property that is moveable or non permanent.
You pay these taxes on cars, boats, RVs, motorcycles, tractors, ATVs, planes, etc. Your car’s annual registration is an example of a personal property tax.
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Taxes on Real Estate Investments
Real estate taxes aren’t the only taxes levied on real estate.
Rental Property Income
Rental property income is taxed at ordinary income rates. However, a whole host of deductions can reduce your tax bill.
And depreciation (including bonus depreciation) is a substantial deduction that can allow the owner to avoid ordinary income taxes for many years of their operations.
Taxes on Real Estate Purchases & Sales
In many states, real estate sales are not subject to sales tax. Unfortunately, some states do charge a sales tax. California calls it a documentary transfer tax.
However, capital gains tax is imposed on profitable real estate sales. Fortunately, that tax bill can be deferred using a 1031 exchange.
Other Real Estate Tax Implications
In this article, I want to keep the focus on real estate taxes. However, the overarching reality of real estate is that it’s highly tax-advantaged. Many people also view it as a safe haven asset for growing and preserving their wealth.
Check out this article if you want a more extensive discussion of the tax advantages of owning real estate.
How are Real Estate Taxes Calculated?
Now, let’s discuss how real estate taxes are calculated. To accomplish this, we need to have three things:
- The property’s fair market value
- The municipality’s assessment ratio (the percentage of a property on which taxes are due)
- The mill levy or tax rate
Assessed Value of Your Real Estate
The local assessor’s office will determine the fair market value of a property. They have three methods (or a combination) by which they can arrive at that property value.
- The comparison or “comp” model arrives at a value by looking at recent comparable sales near the subject property.
- The replacement cost method looks at what it would cost to replace or rebuild the property.
- The income model determines value based on how much income it generates.
Apply Your Municipality’s Assessment Ratio
Believe it or not, real estate taxes aren’t typically calculated on the total value of your property. Instead, they are taxed on a portion or percentage of the property’s fair market value.
That percentage is known as the property assessment ratio, and assessment ratios can vary widely depending on the municipality.
Apply Your Municipality’s Millage Rate
The millage rate or mill levy is the tax rate by which property tax is calculated. One mill is $1 in tax for every $1000 in assessed value. The mill rate varies by municipality.
Each jurisdiction determines the rate they will charge, which is combined to arrive at the tax rate. For example, consider a municipality where the city, county, and school district have jurisdiction over property taxes.
Suppose the school district levies 1.00%, the city levies 0.50%, and the county levies 0.10%. In this scenario, the mill levy would be 1.60%.
Two Examples of Real Estate Taxes
Now that you understand the three components that go into real estate taxes let’s do a couple of hypothetical examples for clarification.
- Fair Market Value – $500,000
- Assessment Ratio – 60%
- Tax Rate – 1.5%
- Fair Market Value – $10,000,000
- Assessment Ratio – 50%
- Tax Rate – 2.0%
($500,000 x 60%) x 1.5% = $4,500 tax payment (Property #1)
($10 million x 50%) x 2% = $100,000 tax payment (Property #2)
Exemptions and Tax Credits for Real Estate
Many states have exemptions to real estate taxes that some people can qualify for. These exemptions can eliminate or reduce the tax rates they’d have to pay. Some examples are:
- Government properties
- Religious group properties
- Senior citizens
- Properties of qualifying nonprofit organizations
- Homestead exemption
Tax credits can also reduce the burden of real estate taxes. Some examples are:
- Rehabilitation tax credit
- Americans with disabilities act (ADA) tax credit
- Low-income housing tax credit (LIHTC)
37th Parallel Provides Tailored Real Estate Investing Solutions
All businesses have expenses, and real estate taxes are no exception. Therefore, it’s important to factor them in during the underwriting process when determining the profitability of an investment property.
And while the municipality has the right to determine the fair market value of a property, the owner has a right to protest their property assessment. Good syndicators do that to keep the real estate tax burden as low as possible.
This is just one of the countless services 37th Parallel Property provides its investors. Top syndicators offer residents a clean, safe place to live while forcing appreciation and maximizing profits for investors. We do this, and it’s part of the 37th Parallel Properties advantage.
We are Multifamily and Real Estate Specialists
Multifamily real estate is all we do. We’ve made our investors money in good times and bad, in bull markets and bear, and even during recessions.
Our 100% profitable track record over more than $1 billion in real estate transactions speaks for itself.
So if you’re an accredited investor, you should be looking at investing in multifamily real estate with 37th Parallel Properties.