What Is Ad Valorem Tax?

Governments at every level levy a variety of taxes to generate revenue. They also use a variety of methods to calculate these taxes. One of the means that taxing authorities use is to base the tax on the value of an item. These taxes are known as "ad valorem" taxes, which comes from the Latin words meaning "according to the value."

What is ad valorem tax, and how is it used in real estate?

One of the most common types of tax in real estate transactions is ad valorem. Local government agencies tax real property in several different ways based on the value of the property. These ad valorem real estate taxes include:

• Transfer taxes as part of the closing costs in a real estate transaction. Taxing authorities levy this tax based on the sale price of a property.
• Annual real property taxes. Taxing agencies base these taxes on the assessed value of the property.
• Capital gains taxes on the sale of real estate. Taxing authorities will levy this tax based on the increase in the property's value upon its sale.

What types of property does the ad valorem tax apply to?

There's a tax attached to all types of property, including real property (real estate) and personal property. Local taxing authorities throughout the country impose ad valorem taxes to real estate. This includes county, municipal governments, and school districts. This annual tax is based on the assessed value of real estate in their jurisdiction. Most state governments collect ad valorem tax on tangible property, like motor vehicles and personal property used in businesses.

How is ad valorem tax calculated?

When ad valorem tax is levied on real estate, the levying body uses the assessed value. An assessed value attempts to gauge the fair market value of a property. When tangible personal property is taxed, taxing authorities typically use the estimated depreciated value of an item.

Once the taxing authority determines the taxable value of an item, it can use that to collect an ad valorem property tax. For example, suppose the local tax collector has assessed a property at $250,000. The agency charges an annual millage rate of 1% based on the assessed value. Thus, the owners of this real estate would receive a property tax bill for $2,500.

What are the factors that determine the value of ad valorem tax?

Taxing authorities base ad valorem taxes on the assessed value of a property. These government agencies will employ a property appraiser to determine a property's assessment value. They'll look at several things to establish this estimate, including:

• The recent sales price of similar properties in the area.
• The value of any recent improvements.
• Any income generated by the property (such as renting out a room).
• The replacement cost.

The problem with basing taxes on assessed and estimated values is that the assessor sometimes gets it wrong. Real estate owners should consider the assessed value to make sure their property hasn't been overvalued. If a real estate owner believes the assessed valuation is too high, they can appeal their property taxes by requesting a reassessment, which is a second evaluation of a property's value. Winning a reassessment can potentially save a property owner lots of money in annual real estate taxes.

It's important to know your tax value

Because ad valorem taxation is based on assessed value, property owners need to ensure that taxing authorities have that number right. If they assess the value of a property above the price it would likely sell for, then the current owner will pay more in taxes than they should. One way to know if their property is overvalued is to keep an eye on similar properties in the area that sell. It won't be exact, but will give property owners a fair idea of how much their real estate is worth in the open market.