A Guide to Property Taxes: Where, Why, and How You Should Pay Them
When you purchase a home, the mortgage and interest aren’t the only expense you need to budget for. Owning a home comes with a few additional obligations, notably property taxes.
Based on the value of your property (the physical structure of your home and the land it sits on), property taxes are a state or local tax levied to cover your portion of expenses for services such as schools, police, fire, garbage pickup, and the amenities that you expect in your community. How much you actually pay depends entirely on the tax rate where your property is located and the assessed value of your home.
It’s important to pay these taxes, as ignoring them can mean big trouble, including a lien on the property, which can prevent you from selling it and can have a significant effect on your credit score.
Table of Contents
- 1 Property Tax Definition
- 2 How Property Taxes Work
- 3 How to Pay Property Taxes
Property Tax Definition
In the simplest terms, property tax is a tax on specific items that you own, collected by your state or local government. Property taxes serve as a primary source of income for your city or state, and are required of almost every property owner. The “almost” is because nonprofit organizations, such as universities and hospitals, do not pay property taxes.
Real Estate and Personal Property Taxes
Property taxes often cause confusion because they are referred to by several different names, which may or may not accurately reflect what they are. For example, you may hear property taxes referred to as “ad valorem taxes,” which simply means a tax on property.
More commonly, though, real estate taxes are confused with personal property tax, which actually refers to different types of taxes. Although both are only levied at the state or local level, and not federally, they are attached to different types of property. Real estate is technically a type of property, so it’s not entirely incorrect to call real estate taxes property or personal property taxes.
However, not all property is real estate, and some municipalities levy an additional personal property tax on other items, such as boats, recreational vehicles, or cars. In some cities, the personal property tax is only levied on businesses, who need to pay taxes on their equipment, fixtures, inventory, and other items they own. Therefore, a good rule of thumb is to remember that real estate taxes are on real estate only, whereas personal property taxes are on other tangible property.
Is Real Estate Tax the Same as Property Tax?
Further complicating matters is the fact that depending on where you live, the terms property tax and real estate tax are used interchangeably. You may receive a bill from your city for property taxes, for example, but when you file your federal taxes, the IRS refers to “real estate taxes” for deduction purposes. The bottom line is that real estate and property taxes are the same things, while personal property taxes are not.
How Property Taxes Work
Again, property taxes are managed by your state or local government. At the most basic level, property taxes are determined by multiplying the assessed value of the property by the prevailing tax rate. Although some municipalities levy taxes based on a percentage, most base property taxes on the mill rate, which equals one one-thousandth of a dollar. For example, if your city’s mill rate is 20 mills, you’ll pay $20 for every $1,000 of your home’s value. If your home is assessed at $150,000, then your property tax bill will be $3,000.
Although there are several different ways to determine the value of your home — and depending on which method is used, the value can vary significantly — most municipalities have a tax assessor (who may be an elected official) conduct property valuations. A variety of factors can influence the assessed value of your home, from its location to the size of the dwelling, the size of your lot, how many bedrooms and bathrooms you have, and even whether you have outbuildings such as a shed or garage.
Tax assessors typically use sophisticated software and algorithms to determine property values, and your assessment can change based on things you do to your home. For example, if you file for a permit to add an addition to your home or make a major remodel, information is sent to the tax assessor’s office. Based on the changes made, the assessor may adjust the value of your home for tax purposes.
The good news is that the assessed value of your home is usually lower (in some cases much lower) than the market value, and in some cities, a portion of your home’s value may be exempt from taxes.
Who Pays Property Taxes?
Property taxes are typically billed annually or biannually — although some cities send quarterly bills — and are sent to all property owners. Again, the notable exception is nonprofit organizations. Even if your taxes are paid directly by your mortgage company via an escrow account, you’re still responsible for confirming that the payment was made and was correct.
What Do Property Taxes Pay For?
Because property taxes are a primary source of income for most municipalities, the funds go towards the services and amenities residents expect, including public safety, schools, road maintenance, libraries, and waste management. Water and sewer improvements and maintenance are also typically funded via property taxes.
Sometimes, cities need additional funds for major projects and need to add a special assessment or non-ad valorem assessment to the property tax bills. Replacing storm drains, for instance, is a project that could lead to a special assessment. These taxes aren’t based on the value of your property, but rather by splitting the cost of the project amongst all property owners.
How to Pay Property Taxes
There are several different ways to pay your property taxes. You always have the option of paying the bill yourself when it arrives; most cities have a tax office where you can pay bills in person or by mail. The drawback to this method is that you need to have enough cash on hand to pay the bill, which could potentially be several thousand dollars.
One of the most common methods of paying property taxes is via an escrow account. With this method, your estimated tax bill is divided by 12, and those equal payments are added to your monthly mortgage payment. Your mortgage company then takes care of sending the payment to your city when the bill is due.
The benefit of paying via escrow is that you don’t have to worry about making big payments once or twice a year, making budgeting simpler. On the downside, your escrow payments are determined on estimated taxes, and if the tax rate increases or your home’s assessed value increases, you may have a shortfall. This can result in you making extra payments to the mortgage company, and changes to your mortgage payment.
Claiming Property Taxes on Your Tax Return
If you itemize your deductions on your taxes, you can deduct what you pay for your property taxes, which could result in a lower tax bill. Married couples filing jointly may claim up to $10,000 in personal property, state and local income, and sales taxes on their returns. For married couples filing separately, the allowed deduction drops to $5,000. This deduction is in addition to the mortgage interest deduction.
Determining How Much You Owe
When you purchase your home, the mortgage company will use information about the local tax rates and the most recent assessed value of your home to estimate your property taxes. This allows them to determine your monthly payments if you will be paying taxes via escrow.
If you aren’t paying taxes through an escrow account and want to estimate your bill for yourself, you can typically find all the information you need from your local tax assessor’s office, often via their website. You’ll need to know the current tax or mill rate, the most recent assessed value of your home, and the amount of any exemptions you qualify for; some states exempt some of the value of the property if it’s the owner’s primary residence or they meet other qualifications, such as being a widow.
With that information, you can get a good idea of your estimated tax bill; simply multiply the value of your home minus any exemptions by the tax rate. You can also use an online calculator to determine your tax burden when value increases are taken into account. In some places, such as California, assessed property values are automatically increased at the current rate of inflation, so the bill will be different every year.
Keep in mind that you can also dispute your property value if you feel that the assessment is incorrect and your bill is too high. You’ll need to contact your local assessor’s office to learn the dispute process and provide evidence supporting your claims, but doing so can reduce your bill significantly if the assessor made a mistake.
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This post was updated January 23, 2020. It was originally published January 23, 2020.