Real Estate Taxes:
A Brief Guide

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.

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. 

Depreciation (including bonus depreciation) is a substantial deduction that can allow the owner to avoid ordinary income taxes for many years of 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 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 determines a property’s fair market value. They use three methods (or a combination) to arrive at that value. 

1. The comparison or “comp” model arrives at a value by looking at recent comparable sales near the subject property.
2. The replacement cost method looks at what it would cost to replace or rebuild the property.
3. 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 it will charge, which is combined to arrive at the tax rate. 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 of real estate taxes let’s use a couple of hypothetical examples to clarify. 

Property #1:

• Fair Market Value – $500,000
• Assessment Ratio – 60%
• Tax Rate – 1.5%

Property #2:

• 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 
• Veterans
• 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)