Taxes, as unpleasant as they may be, are how governments pay for public programs and services. Most everyone in the United States is familiar with federal and state income tax. But if you've never owned real estate or your own business, you may not know how real estate property taxes work.
In medieval Europe, property taxes were based on the size of a piece of land. Generally speaking, the larger the piece of land was, the higher the real estate property tax was.
It wasn't until much later that the value of land came to be seen as the land's ability to output goods and services, and thereby create profit for its owner. Tax assessors began examining other property on the land, including structures, farming equipment and livestock. Why? Governments figured, for example, that if Lord Garish had 1,000 cows, three stables housing 30 horses, a castle and a windmill jammed onto a small piece of land, Lord Garish could afford to pay more property tax than Lord Frugal, who had only 13 cows and a butter churn on a large piece of land.
In the colonies that eventually became the United States, local governments levied a "general property tax" [source: Britannica]. Colonists paid taxes on all property, whether real estate or personal.
Today, property taxes in the United States are mostly based on real property, though some states do tax certain items of personal property. Office buildings are usually taxed according to the rental income they provide for their owners.
In this article, we'll explore how governments use real estate property taxes, how assessors calculate a tax bill and how real estate property tax bills can change over time.
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Real Estate Property Tax Assessments
In the United States, local governments use the revenue from real estate property taxes to fund public services, such as fire protection, law enforcement, roadwork and schools. Without property taxes, local governments would have a difficult time funding these services; property tax revenue accounts for "about half of the revenue raised by local governments" in the United States [source: Britannica].
Taxable property includes any real estate that is not owned by a government, such as houses and companies with brick-and-mortar places of business.
Religious organizations, like churches, are usually not taxable. A tax assessor still assesses the value of government and exempt church real estate, however.
Just as a country has borders and a city has limits, property is divided into assessment areas or assessment units. An assessment area might be a city, a county or even a school district. A property tax assessment is the market value of a property. A tax assessor -- an elected or appointed official -- assesses the value of every taxable property in that assessment area.
It would be a lot of work for the assessor to visit every property in an area. Luckily for everyone, the process is much simpler. Assessments are made by comparing the market value of similar properties. For example, if Mr. MacDonald sells his farm at a price close to his asking price, the tax assessor can use that sale price as a basis for the property tax assessments of farms similar to Mr. MacDonald's.
Every local government has its own real estate property tax procedures.
Generally, to set or adjust a tax rate, local governments must look at how much money comes from various sources of revenue, including sales tax and state aid. This amount is compared to the government's budget for the year. The amount of money needed to fill the gap between the budget and the expected revenue is usually called the tax levy.
For example, the Rose City government has a $6 million budget and receives $3.5 million in sales tax revenue and state aid. Rose City needs to raise $2.5 million in property taxes to cover the budget.
$6,000,000 - $3,500,000 = $2,500,000
The fundamental idea of the modern property tax is to provide revenue for public services. It follows, then, that real estate property tax rates vary widely across the United States according to the needs of individual local governments. One city uses property tax revenue to repair roads riddled with pot-holes, while another city uses the revenue to hire more police officers to fight a gang problem.
Usually, real estate property tax rates don't change much over time. Governments are more likely to change the rate at which properties are assessed, called the assessment rate or assessment level. Learn what other factors can change a real estate property tax bill on the next page.
What Makes Real Estate Property Tax Bills Change
As mentioned earlier in the article, an actual property tax rate rarely changes. If a government needed to bring in more revenue through real estate property taxes, it's more likely that the government would increase the assessment value. Increasing the assessment value would increase the taxable value of your property. Multiply this higher taxable value by the same old property tax rate, and you've got yourself a bigger tax bill.
What else might cause your tax bill to change? Real estate tends to increase in value over time. Because of this, property tax assessors usually reassess the value of real estate every few years. For example, county tax assessors in Illinois reassess properties every four years (every three years in Cook County) [source: Illinois Department of Revenue]. When real estate increases in value, the first number in the property tax equation increases, thereby increasing the tax bill. To avoid excessive property taxes as real estate increases vastly in value, a government might adjust its assessment or tax rate.
A decrease in real estate value, perhaps due to natural phenomena (a housing development becomes a flood plain) would have the opposite effect on the tax bill. But if a local government can't afford to lose the revenue it acquires through real estate property taxes, the government might increase its assessment rate or even its property tax rate.
When new businesses come into a community, they generate income. When people build new houses on previously undeveloped land, property value increases. In these cases, your tax bill could actually decrease, because the property tax could be spread across more properties.
Changes in a government's budget also could increase or decrease your tax bill. If your town government wants to build a new high school, the town government's budget might increase. If the government can't get funding through other sources, a change in the property tax calculation could increase your tax bill. Likewise, a smaller budget could decrease your bill.
Local governments make a lot of money from sales taxes. If tourists flock to your town every summer to participate in the Rose City Festival of Toys and Miniatures, your town government probably receives a nice influx of revenue from summer tourism. If turnout at the festival declines over the course of several years, your local authorities may look to other sources of revenue to make up for the shortfall. They may look to increase real estate property taxes.
It's great that your local government's budget is so healthy, but what about your own budget? On the next page, learn how to make your real estate property taxes work for you at income-tax time.
How Real Estate Property Taxes Affect Income Taxes
After paying all this money, it would be nice to get a break. Fortunately, come April 15, you get one. As you calculate your personal income tax, you can often deduct what you have paid for real estate property taxes.
In most cases, you may deduct what you pay for state, local and even foreign real estate property taxes. These taxes are deductible from your income tax as long as:
- the taxes go toward general public welfare
- the taxes are based on your property's assessed value
- all properties in the assessment area are taxed at the same rate
You may not deduct taxes that ultimately increase the value of your property or that are charged for local benefits, such as sidewalks and sewer lines. But the news isn't all bad. Though you may not be able to deduct those taxes, you may be able to use them to increase the cost basis of your property. And some local benefits -- usually relating to maintenance and repair -- are deductible. If you're not sure if a given property tax is a deductible expense, IRS Tax Topic 503, "Deductible Taxes" and Publication 530, "Tax Information for First-Time Home Owners," can offer some clarification.
To deduct your real estate property taxes from your personal income taxes, you'll need to file a 1040 long form and Schedule A. And you should check to make sure the standard deduction isn't better for your situation. You should also check with a licensed tax consultant.
If you own a second home, it can also offer a tax break. You can deduct both your mortgage interest and your property taxes on the second home -- again, as long as you itemize. And of course property taxes on the second home must meet the same requirements as those on your first home.
If you'd like to know more about real estate property taxes and related topics, you can follow the links on the next page.
Related HowStuffWorks Articles
More Great Links
- Bankrate.com "How to fight your ballooning property tax." http://moneycentral.msn.com/content/Taxes/Cutyourtaxes/P57816.asp (Accessed 4/21/08)
- Encyclopedia Britannica. "property tax." http://www.britannica.com/eb/article-9108615/property-tax (Accessed 4/20/08)
- Encyclopedia Britannica. "property tax: Administration." http://www.britannica.com/eb/article-71972/property-tax (Accessed 4/20/08)
- Encyclopedia Britannica. "property tax: Tax rates." http://www.britannica.com/eb/article-71973/property-tax (Accessed 4/20/08)
- Encyclopedia Britannica. "Theory of property taxation > Economic effects." http://www.britannica.com/eb/article-71975/property-tax (Accessed 4/20/08)
- Florida Department of Revenue. "Property Tax Exemptions." http://dor.myflorida.com/dor/property/exemptions.html (Accessed 4/24/08)
- http://www.homegain.com/info_center/buyer/faqs/taxes#proptax (Accessed 7/18/08)
- Investopedia. "Property Tax." http://www.investopedia.com/terms/p/propertytax.asp (Accessed 4/21/08)
- IRS, Real Estate FAQs. http://www.irs.gov/faqs/faq3-6.html (Accessed 7/18/08)
- IRS, Tax Topic 503, "Deductible Taxes." http://www.irs.gov/taxtopics/tc503.html (Accessed 7/18/08)
- Los Angeles County Office of the Assessor. "An Overview of the Property Tax and Assessment Process." http://assessor.lacounty.gov/extranet/Overview/overview.aspx (Accessed 4/21/08)
- Los Angeles County Office of the Assessor. "Personal Property Assessments." http://assessor.lacounty.gov/extranet/guides/persprop.aspx?pos=2 (Accessed 4/21/08)
- MSN Money. "Property Tax." http://moneycentral.msn.com/taxes/glossary/glossary.asp?TermID=263 (Accessed 4/20/08)
- Illinois Department of Revenue. "An Overview of Property Tax." http://www.revenue.state.il.us/LocalGovernment/PropertyTax/PIO-16.PDF (Accessed 4/21/08)
- NYSORPS. "How the Property Tax Works." New York State Office of Real Property Services. 3/21/07. http://www.orps.state.ny.us/pamphlet/taxworks.htm (Accessed 4/21/08)
- Youngman, Joan and Reschovsky, Andrew. "The strengths of the property tax." The Boston Globe. 9/22/07. http://www.boston.com/news/globe/editorial_opinion/oped/articles/2007/09/22/the_strengths_of_the_property_tax/ (Accessed 4/21/08)