What Are Property Taxes and How Do They Work?

Taxes are the main funding source used by the government to finance various services and projects. Property taxes are one of the biggest sources of income for the state. In this article, we’ll answer the question, “What are property taxes and how do they work?” and explain how it is calculated.

We’ll also discuss how you can ensure the accuracy of your property taxes, as well as what you can do in case you want to dispute any calculations. We’ll also provide other crucial information to help you understand property taxes.

Property Taxes Explained

Property tax is the tax you pay for your property, and it’s computed using the value of both your land and all properties that stand on it. Commonly, it’s a real estate ad valorem tax that’s also regressive. This means that authorities impose the same percentage on the property regardless of your income.

How Do Property Taxes Work?   

In this segment, we’ll show you how property taxes work. It seems complicated at first, but it’s actually very simple — we’ll dissect it for you.

Types of Property Taxes

There are three general types of property taxes:

  • Land taxes – charged on the owner of land not including the value of properties on it.
  • Real estate taxes charged for the land plus the immovable buildings standing on the location.
  • Personal property taxes – charged on any item considered as “personal property,” or movable properties not attached to a home or building. Examples include motor vehicles, aircraft, and boats.

Who Decides the Tax Rate? 

Jurisdictions on all 50 US states and the District of Columbia impose property tax levies.

Most states impose real estate taxes in counties, municipalities, townships, school districts, and special districts.

Some states impose taxes on personal properties, too, such as machinery, equipment, and motor vehicles. Each jurisdiction has its own tax rate, so they calculate taxes independently of each other.

Assessment Period

A property appraiser does assessments once a year or every 5 years, depending on state or local laws.

The assessment comes from the appraiser’s estimation of the market value of your property, and you should receive the assessment first before you get billed.

Factors that Influence the Assessment Value of Your Property 

In answering the question, “What are property taxes and how do they work?” it pays to know what factors affect the value of your property. Here are some critical factors to consider:

  • Vacant vs improved: the nature of the improvements — or lack thereof — made on the land can significantly affect the assessed value of the property. For instance, erecting a home or warehouse on a once-vacant piece of land can markedly increase its value.
  • Access to public services: if the property is located somewhere near public services, such as sewers, gas, and water stations, its value may also be markedly increased. That being said, note that public utility taxes often end up on the utility bills we pay each month.
  • Development potential: the property’s value may also go up if there’s a good potential for development. For instance, a remodeled or renovated kitchen can increase your house’s value, and so your home taxes will also rise.
  • Income: if you derive income from a property, such as renting it to tenants, that income isn’t taxed. If you sell the home or property, you may exclude your capital gains from federal taxable income. If the estate generates more than $600 in annual gross income, you may need to file IRS form 1041, for which you can use some great 1041 tax software.

What are Property Taxes Used For? 

So, what is property tax used for? They essentially provide the largest source of funding for local governments. The local government in turn finances important services and projects such as:

  • District projects
  • Police and fire departments
  • Road construction
  • Local services
  • Local and state governments

How Are Property Taxes Calculated?

When it comes to calculations, a property appraiser takes the following steps:

  • The appraiser estimates the property’s market value using one of those 3 methods:
    • Sales evaluationconsiders the economic and social trends on top of governmental regulations and conditions that may affect the demand, utility, scarcity, and transferability of the property.
    • Cost methodestimates the price a buyer should spend to build a similar property. The appraiser uses the formula: (cost of land + cost of construction) – depreciation. 
    • Income methodestimates the property’s value based on the income that it generates. The formula is net operating income/capitalization rate. 
  • Then, the appraiser calculates the assessment value by using this formula: market value x assessment rate in decimal = assessment value. 
    • Go to your city or county’s website or contact a city official to get the assessment rate.
  • To finally arrive at the actual property tax valuation, multiply the assessment value by the millage rate.
    • The millage rate represents the amount you need to pay for every $1,000 of your property’s assessed value. It’s the tax rate used to calculate your local property tax.

Knowing the above steps not only helps you understand how assessors arrived at the property tax assessed value but also helps you in case you want to dispute or lower your property taxes.

What Happens After a Property Tax is Calculated?

After the property tax is calculated, you are informed of the assessed value. Then, you receive the bill.

Paying the tax bill is the final step in answering the question, “What are property taxes, and how do they work?”

Typically, you can pay the tax by:

  • Writing a check or paying online once a year or every 6 months when the bill comes
  • Setting aside funds in an escrow account when you pay the mortgage

But what happens when you fail to pay your local property taxes? You’ll receive a late payment penalty plus administrative fees.

As an example, California counties charge a 10% late payment penalty on a delinquent first installment property tax bill. If you continue to miss payments, the taxing authority may also place a tax lien on the property.

What if the Owner of the Property Disagrees With Its Assessed Valuation?

You don’t necessarily need to accept the bill. You can disagree with the assessed valuation of your real estate taxes, and in some cases, you can even lower it. You can contest a property’s assessed valuation by:

  • Gathering comparable listings: search for 3 to 5 comparable properties that have been appraised recently. The properties must be similar to your own in terms of size, style, condition, and location. Check if assessments align and if you can make a case for a lower valuation.
  • Asking a real estate agent for comparable sales: the agent may pull property tax records on comparable properties to compare valuations. You may find superior properties that have similar valuations to yours and appeal for a lower assessed value.
  • Calling the assessor’s office to know the dispute process: the assessor’s office will guide through the due process from property tax definition to how each step of assessment works to shed light on how the assessor came up with the valuation.

If you still disagree, you can initiate the dispute process. You may present evidence for your case, and the quasi-judicial body will either increase, decrease, or retain the assessed value of your property.

  • Pursuing the case with an independent tax appeal board: you may also seek help from an independent tax appeal board, which is an independent entity that resolves disputes between taxpayers and assessors over real property taxes. Their decisions are legally binding, although they cannot grant or deny tax exemptions.

Other Useful Information on Property Taxes

Although the following are last on this least, they’re still crucial to know when it comes to dealing with property taxes.

  • Assessment evaluations appear on public records: tax records are public information. Your name, the property value at the time of assessment, and due and paid taxes are accessible to the public.
  • Where to look up assessment evaluation: you can look up evaluations for a fee either through a property assessor’s website or your county’s courthouse.
  • Avoiding taxes: if you fall behind tax payments, you can receive a tax lien, which is a legal claim against unpaid property taxes. When a property has a lien, you can’t sell or refinance it until you’ve paid all property tax levies on it and the lien has been discharged.
  • Tax liens on credit report: property taxes aren’t reported to your credit report. However, if a tax lien is issued on your property, it will be reflected on your credit report and may affect lenders’ perception of you as a borrower.

You may submit a 609 letter to request the removal of negative information from your credit report, thanks to section 609 of the Fair Credit Reporting Act. However, this doesn’t guarantee that the tax lien will be removed from the report.

  • Deducting property taxes on tax returns: if you itemize your tax returns, you can deduct property taxes on any real estate you own. This includes the property taxes you pay starting from the date you purchased the property.
  • Effective property tax rate: you can calculate your individual property’s effective tax rate by dividing your annual tax bill by your estimate of the market value of your property. For instance, if you own a property that’s worth $300,000 and your annual tax is $10,000, then your effective tax percentage is 3.33%.

Conclusion

Property taxes are calculated based on your property’s market value and the tax rate of the jurisdiction. The real estate value includes the land value and the cost of all immovable buildings or properties on it. The bill comes either annually or biannually, and the funds are used by the state government to finance public services and government projects. Paying your property taxes on time helps you avoid tax liens and penalties.

FAQ

What type of tax is property tax?

Property tax is a real estate ad valorem tax. It can be considered as a regressive tax because if two individuals in the same tax jurisdiction live in properties with the same values, they’ll pay the same amount of tax regardless of income. That said, the tax depends on the property’s value.

What does property tax include?

Property taxes are calculated using the property’s value, which includes the land and all immovable objects on it. Value assessors calculate the value using the millage tax and multiplying it with the assessed property’s value. If you’re doing mortgage payments, property taxes are often rolled into your monthly mortgage bills.

How much do property taxes cost?

Property taxes cost differently per jurisdiction, depending on the millage rate imposed by the county, township, district, or state. As a result, taxing authorities encourage payers to understand how the taxes are calculated and do their part in remaining educated about such taxes, billing cycles, rates, and other crucial information.

What is personal property tax?

Personal property taxes are a form of property taxation imposed on what is considered “personal property.” In this context, personal property is any movable property that’s not attached to a home or building, such as machinery, motor vehicles, aircraft, and boats.

How is property tax paid?

You can pay your property tax bill either as part of your monthly mortgage payments or directly to your local tax office. For mortgage payers, the lender rolls your property taxes into your bill. If you pay directly to the tax office, you can pay by check, online, or telephone.

Is property tax annual?

Yes, property taxes can be paid annually. They can also be paid biannually (or twice a year) on March 1 and September 1. The payments in advance. For instance, your March payment covers the period between March and August, while your payment on September 1 covers September to February.

Is the property tax federal or state?

Property taxes are state taxes. Individual states impose independent limitations on local jurisdictions. Since many properties are subject to tax by more than one jurisdiction, a number of states provide a method to make values uniform among multiple jurisdictions. In addition, property taxes do not go to the federal government.

Should I do my own taxes?

The answer depends on your knowledge and time. If you’re confident in your know-how and can spare time to learn how to do your taxes for the first time, go for it. However, it’s generally advised for people with businesses to hire an accountant to help them go through records gathering and preparing taxes.

Do you pay tax assessment?

No. Tax assessors are local government officials that determine a real estate property’s value for taxation purposes. They’re the experts in answering the question, “What are property taxes, and how do they work?” Meanwhile, you must pay for an appraiser’s services, which works as tax assessors except in private practice.

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