Taxes and Assessments
In This Chapter
- Real estate taxes and how they’re assessed
- Real estate tax calculations
- The differences in tax exemptions available
- Tax lien sales and how they work
One of the powers conferred by governmental powers is the right to tax, or taxation. This power grants the government the right to collect taxes in many ways, including sales tax, income tax, and of course real estate taxes.
In this chapter, we will discuss real estate taxes: how they are calculated, assessed, and collected. Understanding the way real estate gets assessed is a key factor in being able to determine the cost of taxes on real estate. Within the real estate taxing process, there are several exemptions a homeowner can claim. We will cover the different types, their values, and how they protect a homeowner.
The right to tax real estate enables the government to impose and collect taxes on real property. There are typically two types of real estate taxes: ad valorem taxes and special assessment taxes.
Real estate taxes are assessed on most privately owned properties. Some communities, such as parts of Alaska, do not impose taxes on real property. The revenue generated from real estate taxes are used to help pay for local services like road maintenance, snow removal, public schools, and the operation of local government offices. Real estate taxes are calculated as a percentage of a property’s tax value.
Taxes levied against real property have a high degree of certainty of collection so tax liens are very rarely, if ever, recorded.
How Taxes Are Levied
A property tax is a levy an owner is required to pay on real property. The tax is imposed, or levied, by the governing authority that holds jurisdiction over the area where the property resides. Property taxes may be paid to a federal government agency, a state government agency, a county government agency, or a municipality. In some cases, multiple government agencies may tax the same property.
There are four broad types of property: land, improvements to land such as buildings, personal property, and intangible property. Real property refers to the land and all the naturally occurring elements plus any manmade improvements on it. Under a property tax system, the government requires and performs an appraisal of the value of each property, and tax is assessed in proportion to that value, called the assessed value.
Different forms of property tax are used among state, local and municipalities, while real property is often taxed based on its classification. Classification is the grouping of properties based on similar use. Properties in different classes are taxed at different rates. Examples of different classes of property are residential, commercial, industrial, special use, and vacant real property.
A special assessment tax is sometimes confused with property tax. These are two distinct forms of taxation: ad valorem tax, which relies on the assessed value of the property being taxed, and special assessment tax, which relies on a special enhancement called a benefit to the property and its owner.
The property tax rate is often given as a percentage. In some cases, it also may be expressed as a mill, or a millage rate. A mill is 1⁄1,000 of $1, or $0.001. For example, 40 mills would be 40⁄1,000 of $1, or $0.040, or 4 percent. This would mean the tax rate would be $40 for every $1,000 in value.
DEFINITION
The tax rate is the amount at which real property is taxed and is established by most state taxing authorities. A mill is 1⁄1,000 of $1, or $0.001. Tax rates are typically set by statute in each state.
How Taxes Are Collected
After the taxes have been levied against a piece of real property, the next step is the collection of the taxes. A property’s tax bill is calculated by multiplying the tax rate and the assessed value along with an equalization factor.
The date taxes are due, called the penalty date, is typically set by state statute. Property taxes are payable in two semiannual payments, four quarterly payments, or twelve monthly payments. Some states pay taxes at the beginning of the tax year, called prepaid; others pay at the end of the tax year, called arrears. Furthermore, some states pay taxes a full year in arrears—that is, they pay last year’s taxes in this year’s calendar year. States that offer monthly payments also may offer a discount if the taxes are paid in full.
All states charge a penalty in the form of interest on taxes not paid by the penalty date. Should the taxes go unpaid for an extended period, most states offer the property at a tax sale (discussed later in this chapter).
How Taxes Are Calculated
Ad valorem and special assessment taxes are calculated in different ways, but they may be paid as one bill in most states.
The ad valorem (Latin for “according to value”) tax is a simple calculation that requires the knowledge of the tax rate, equalization factor, and assessed value. Typically, the ad valorem tax is an annual value levied against property. For example, a house with an assessed value of $100,000 is in an area with a tax rate of 23 mills. The house has an equalization factor of 0.80. What are the monthly taxes?
Ad valorem = tax rate × assessed value × equalization factor
So:
Ad valorem = 0.023 × $100,000 × 0.80 = $1,840 per annum
The monthly tax rate is $1,840 ÷ 12 or $153.33 per month.
DEFINITION
The equalization factor is a number, or factor, by which the assessed value of a property is multiplied to arrive at a value for the property that’s in line with statewide tax assessments. If an equalization factor is not mentioned or present, it’s assumed to be equal (i.e., 1).
A special assessment tax is levied to cover the costs of improvements that will benefit everyone who is taxed. The proceeds of a special assessment tax could be used for new sidewalks in a community, new streets to gain access to a housing addition, or sewer lines to replace the old septic tanks in an area.
A special assessment tax can be assessed in any manner the taxing authority determines equitable. The two most common methods are pro rate and equal fashion. For example, a neighborhood of 10 houses, under a special assessment tax, is required to pay for a new road, costing $50,000, and sidewalks, costing $15,000. The road should provide equal benefit to all houses so the $50,000 is divided equally between the 10 houses, giving a tax levy of $5,000 per house. The sidewalks may benefit some houses more due to them having a larger yard than others. Suppose of the 10 houses, 5 had double lots and 5 had single lots. The five with double lots might pay double the tax the other five pay. Therefore, five houses would be levied $2,000 while the others only $1,000.
If the amount of the special assessment tax is too large, some states allow for equal payments to made along with the ad valorem tax, rather than one lump sum.
Exemptions for Real Estate Owners
Although all property is assessed, not all of it is taxable. Some properties, such as those owned by religious organizations or governments, are completely exempt from paying property taxes. Others are partially exempt, such as veterans who qualify for an exemption on part of their homes. Most exemptions are offered by the local taxing authority, such as a municipality, a county, or a school district.
Other forms of exemptions exist for property belonging to the United States, property belonging to the state, property belonging to the municipality, reservation land, university and college property, property held for cemetery use, hospitals and sanatoriums, airport improvements, Public Service Railroads, and anyone who asks and is granted an exemption. Some taxing authorities also grant special exemptions to large industries that employee many workers or sports teams they determine to be important to the economic benefit of the area. Check with your local assessor to determine what exemptions are available in your community.
In general, exemptions, no matter the type, work by reducing the overall assessed value of the real property, thus reducing the tax burden levied on a property owner. For example, if a property has an assessed value of $100,000 with no exemptions, it would be taxed at the full value. However, if the property has a $45,000 exemption, such as Indiana’s homestead exemption, the property would be effectively taxed as if the value was $55,000 ($100,000 – $45,000). This new effective value would reduce the homeowner’s overall property taxes. Furthermore, if a property has been granted multiple exemptions, they would be cumulative in nature. The total amount would be deducted from the assessed value, as before.
Types of Exemptions
Several different types of exemptions can be granted to private property. Typically, they’re only partial exemptions rather than full exemptions.
Depending on the state, numerous exemptions are available for property owners. All real property owners have the right to apply for any exemption for which they qualify, including, but not limited to homestead, mortgage, senior citizen, disabled citizen, widow/widower of veteran, historic property, or home improvement.
A homestead exemption provides for the exemption in assessed value from the property tax assessment of any real property owned and occupied as a principal place of residence.
Different states provide different degrees of protection under the homestead exemption laws. Some states protect property by dollar value, some on acreage limitations, and others use both. If a person’s debt exceeds the limits of protection granted by the state taxing authority, creditors may force the sale to satisfy the outstanding debt.
Let’s look at some examples of exemptions. California protects up to $75,000 for single people, $100,000 for married couples, and $175,000 for people over 65 or legally disabled. Texas’s homestead exemption has no dollar value limit and a 10-acre exemption limit for homesteads inside urban areas and 100 acres for those in rural areas outside the city. Both the Kansas and Oklahoma exemptions protect 160 acres of land, of any value, in rural areas while only exempting 1 acre in the city. Indiana has a $45,000 exemption. New Mexico has a $60,000 exemption. Alaska has a $54,000 exemption. Colorado has a $60,000 exemption, or $90,000 for people who are over 60 or disabled. In most states, the real dollar value of protection provided by these laws has diminished over the years because exemption dollar amounts are seldom adjusted for inflation. Therefore, this protective intent of exemptions has been eroded in most states.
In a few states, real property that has a lien and mortgage recorded against it also will be able to seek a mortgage exemption. The value of the exemption differs in every state. Indiana’s, for example, is $2,000.
Most if not all states have an exemption for senior citizens to help reduce their taxes. Every state differs in the exact requirements, so check with your taxing authority to find the exact rules for your state, if any. Most states have an age requirement, typically between ages 62 and 65, while other states have added a household low-income component.
Most states have a disabled citizen exemption. To qualify, the taxpayer must be “unable to engage in any substantial gainful activity because of a physical or medical impairment ….” In all states that grant this exemption, proof requirements must be met in advance before applying for the exemption.
In some states, any widow or widower of a veteran may claim this exemption. If the widow or widower remarries, they would no longer be eligible for the exemption. If a husband and wife were divorced before either of their deaths, they are not considered a widow or widower and not allowed the exemption. When filing for the first time, a death certificate may be required.
To qualify for the historic exemption, properties may be residential or commercial and must be either individually listed in the National Register of Historic Places, a contributing building in a National Register District, or designated as historic under the provisions of a local preservation ordinance.
To qualify for a home improvement exemption, the residential property must be occupied by the owner and be bettered in value due to an addition or improvement to the property. Most states have a maximum value that can be exempted regardless of the increase in the value added. For example, in Illinois, the maximum amount of exemption is $25,000, even if you improved the value more than that. Furthermore, some states only grant the exemption for a time period, and at the end of it, the value would level up. So the $25,000 exemption may be for only the first 4 years after the improvement happened, for example.
These are just a few examples of exemptions granted in various states. Some states may have more opportunities for exemptions, while others may not offer any of these at all, except for the homestead. Check in your state to see exactly what exemptions may be available.
Full Versus Partial Exemptions
HELPFUL HINT
All states offer a homestead exemption in some manner. In some states they offer a full exemption—an exemption for the full value of the property—while other states only offer a partial exemption—only a portion of the value of the property.
Exemptions can range from full to partial relief of a homeowner’s tax liability. One authority may provide a full exemption for real property, like Texas, whereas another authority may provide only a partial exemption for these types of property. The limitations can be expressed in terms of dollar amounts or by a percentage of value.
Full exemptions typically defer the entire amount of the property tax burden. This type of exemption can be granted only by a taxing authority with the approval of the controlling government entity, such as the state, local, or municipality. Typically, full exemptions are reserved for large companies that can bring a large impact to a city. The foregoing of property tax gained by the city is offset by the influx of workers who would stimulate the city’s economy.
Partial exemptions only reduce, not eliminate, the tax burden a property owner could be levied based on each exemption’s value. Partial exemptions are primarily given to private individuals as a benefit to reduce their overall real estate taxes.
Tax Lien Sales
A tax sale is the forced sale of real property by a governmental entity due to the property owner failing to pay taxes. Depending on the state, the sale may be a tax deed sale, where the actual property is sold at the sale, or a tax lien sale, where a lien on the property is sold. With the tax lien sale, the buyer is merely buying the lien on the property rather than the property itself. Basically, the buyer is taking out the taxing authority by buying their place in line.
Before either of these situations can happen, the tax must be on a charged property, applied equitably to all properties and for a legal purpose. This makes the real estate taxes valid and enforceable by the taxing authority. After some statutory period of nonpayment of real estate taxes, typically 1 or 2 years, the taxing authority offers the property at auction. The date, time, and location must be disclosed to all parties in a public newspaper as well as in a certified letter to the property owner.
Because the outstanding balance of taxes owed is known, the minimum bid must be at least equal to that outstanding balance. The auction’s highest bidder is given a certificate of sale when the bidder pays the cash to the taxing authority. In some states the holder of the certificate may take possession of the property immediately, while in others, there is a statutory period of redemption for the owner losing the property (more on this in upcoming “Statutory Right of Redemption” section).
Equitable Right of Redemption
All states allow for the equitable right of redemption, or the paying of past-due real estate taxes. Once the property owner has been notified that his property will be included in a tax sale, he has the right to bring the balance current by making a payment before the sale date.
In most states, he must bring the entire balance due—late taxes plus any accrued penalties and interest. Some states go one step further and require the payment of the next installment of taxes as well.
Statutory Right of Redemption
The statutory right of redemption is a state law used by some states to allow a property owner to reclaim his property even after the tax sale has occurred.
Most states are categorized as either tax lien or tax deed states. In tax deed states, buyers purchase the tax deeds to own the properties immediately, thus with no statutory right of redemption. However, purchasers of tax lien certificates do not immediately own the properties upon purchasing said certificates. They may not acquire possession of the properties or evict property owners. The homeowners may remain on the properties during the redemption period set by state statutes.
To regain their property during the statutory right of redemption period, a property owner must pay the entire sum of back taxes plus interest, mandated by each state (usually 4 to 18 percent), to the tax lien holder. The timeframe for the redemption period varies from state to state; it may be anywhere from 6 months to 4 years.
Tax lien states are Alabama, Arizona, Colorado, Florida, Illinois, Indiana, Iowa, Kentucky, Maryland, Mississippi, Missouri, Montana, Nebraska, New Jersey, North Dakota, Ohio, Oklahoma, South Carolina, South Dakota, Vermont, West Virginia, and Wyoming. The District of Columbia is a tax lien jurisdiction as well.
- Taxes are paid on real property based on the assessed value.
- Taxes are based on ad valorem or special assessment.
- Tax rates are expressed in mills or 1⁄1,000 of $1.
- Property owners can be granted exemptions for many different issues to reduce the overall burden of taxes on real property.
- Properties can be sold at a tax sale for unpaid real estate taxes.
- Some states allow property owners to reclaim a property sold at a tax lien sale, even after the sale is completed.