Property taxes are a given if you own a home or piece of real estate. Though the bills can often be hefty, they’re a necessary part of living in a community -- helping fund local schools, infrastructure, first responders, and government.
But exactly what determines property tax? And are there ways you can reduce the taxes you pay on your investment properties or other real estate purchases? Let’s dive in.
What are property taxes?
Put simply, a property tax is a tax levy against a piece of real estate. It’s a major source of income for both local and state governments and services. Sometimes, property taxes are also called "ad valorem taxes."
Property taxes have been around since at least the 1800s. And though their popularity with states has ebbed and flowed over the centuries, according to a study conducted by the University of Maryland and the National Bureau of Economic Research, they’ve been a consistent presence in the U.S. ever since. In fact, in 1902, property taxes accounted for about 73% of all local government revenue.
How are property taxes determined?
As you can see in this research I did earlier this year, property taxes vary widely based on location -- and that’s because tax rates, as well as the costs of local services, vary just as much.
Here are the elements that will factor into the final tax bill on your investment properties:
Your property’s value
Every year, you should get a property assessment in the mail from your local appraisal district. This will note the estimated value of your home and the lot it stands on.
These assessments can be conducted in three ways, depending on where you live. These include:
- Fair market value: This uses recent similar property sales to determine what your property would fetch on the open market.
- Replacement cost: This is more like how insurance companies look at your home, determining how much it would cost to fully replace your home considering its age, condition, and other physical factors.
- Income: This is more common on business and rental properties. It’s based on how much income a property generates within a year.
If you feel your property’s value is higher than it should be, you may be able to dispute it and have the value lowered. We’ll go into that a bit more later.
The total mill levy for each service in your area
Every taxing district and service will have a different tax rate depending on how much money it needs to operate. If, for example, a county needs $2 million to operate, they would divide that number by the total assessed property value (let’s say $200 million) within its borders to get its specific property tax rate (also called a millage rate or mill rate). In this case, it’d be 1%.
School districts, cities, community colleges, water districts, and others do this as well, each charging their own millage rate based on how much budget they need to operate.
Your property value is multiplied by these various tax rates
Finally, these various tax rates will be multiplied by your property’s total value to get your total tax bill. You should get a document in the mail breaking it all down, including the individual tax rates of all these services, how much your taxes are for each one, and the total of all individual tax charges added up.
Depending on how your mortgage is structured, you may need to pay this bill directly with the tax assessor’s office or forward it on to your loan servicer to be paid from your escrow account.
How to reduce your property taxes
If you’re looking to lessen that property tax burden, your best bet is to look at potential exemptions in your area. These let you either: 1) lower your assessed value by X amount, thus reducing the taxes you owe on the property or 2) lower your actual property tax bill by a specified amount.
The exact exemptions you’ll have available will depend on your location, but some common ones include:
Don’t forget: You can also deduct your property taxes from your taxable income -- as long as you itemize your returns. They might also qualify as business expenses, depending on how you handle your investments. Both of these can reduce the financial hit you take due to your tax bill.
Can you dispute your property tax bill?
You can’t dispute your actual tax bill, but you can dispute your property tax assessment -- or how much the taxing jurisdiction thinks your property is worth. This is also called "appealing" your property assessment.
The process for filing a property tax protest depends on your specific location, but it generally looks something like this:
- Contact your local appraisal office or taxing authority to retrieve the proper appeal forms. You usually have anywhere from 30 to 90 days to submit these forms after receiving your assessment. (These deadlines vary, so be sure to check!)
- You should then check your county’s property records to make sure the information is correct. If the square footage or age of your property is off, it could impact your assessment.
- You’ll next need to produce documentation or proof of why your property’s valuation should be lowered. This might include a recent sales contract (if you just bought the property in the last year or two), an appraisal (if you refinanced), photos (to show there’s damage or a major repair needed), or a comparable sales analysis (showing recent sales lower than your current value). Depending on your jurisdiction, this documentation may need to be included with your appeal forms.
- In some cases, you might need to attend an in-person hearing with an appraisal board or judge. This is when you’d present your argument and any documentation you have and make your case for a lower assessment.
There are some tax companies and attorneys that offer property tax protest services, but these generally aren’t necessary. Though they could help increase your chances of success slightly, most appraisal districts make appealing your assessment fairly easy (you can often do it virtually, too). Outsourcing to a pro would only eat into any savings you might net if you’re successful.
The bottom line
Property taxes certainly cut into your bottom line as an investor, but they’re a necessary part of buying and owning real estate. Make sure to take advantage of any exemptions that could reduce your taxable value, and don’t be afraid to protest your assessment. The biggest consequence you might face? A little lost time.