Hi friends, I hope you all had a fantastic few weeks. I’m back with part 2 of “What to know when buying a home”, and this week I want to tackle assessed value and property taxes. The two are interrelated, so it makes sense to talk about them together.
What are property taxes?
Property tax is a tax on real estate by your local government. It is assessed at the municipal or county level, and is typically between 0-4% of the value of the real estate. In other words, the government is using your house as a basis to tax you so that they can have revenue to keep operating (and thus, keep taxing you).
Depending on where you live, property taxes can be anywhere from a few thousand dollars a year or, if live in a state where housing prices are higher, then maybe closer to 7-10 grand.
Who’s doing the taxing?
The government is the proverbial “that guy”, always finding a way to tax you, but its recognition of the value of your property leads to good things like the ability to back up your efforts build equity in your home and maintain a stable housing market. Not to mention property taxes are the main tax supporting education, police and fire protection, and other miscellaneous things you didn’t know the government took care of for you.
Wherever you are, you can thank your local treasurer the next time you see him or her for this lovely once-a-year expensive tax for residing in their jurisdiction.
Hopefully I’ve done my social due diligence in explaining what property taxes are and why they’re necessary, so we’ll get to the real point of this post: know what the property taxes are on a home before buying a home. Knowing how much you’re paying to live in a specific house or neighborhood is good for your overall financial well-being.
Learning the Lingo
To best understand property taxes, it’s helpful to discuss a few different terms: fair market value, assessed value, caps, and taxable value. They are all related, but differ slightly in how they relate to property taxes. What follows is a summary of an excellent post by thenest.com.
Fair market value – the price your home would sell for with a willing buyer and seller under normal market conditions. Fair market value can be determined by a real estate appraiser, but more informally, think of it as “what the place is worth” on the free market.
Assessed value – the government employs real estate appraisers to approximate value for an area and increase or decrease the assessed value by an across-the-board percentage. Known in the industry as a blanket or mass appraisal, it’s different than a fair market value appraisal. Your taxing district uses assessed value to calculate taxable value (which you pay property taxes on).
Caps – States typically limit the amount that property taxes can increase each year; this is known as a “cap”. If your taxing district calculates an assessed value that would cause your property taxes to go above that cap, a restriction comes into play that limits your taxes to that capped assessment/property tax amount. They can, however, carry forward that increase in assessed value in future years until you’re paying the new rate. The bad news is that caps don’t usually apply when the property changes hands, giving the taxing authority the power to increase property taxes.
Taxable value – Certain states have laws that give you a break when it comes to property taxes. In Iowa, where I live, you can get taxed on up to 100% of assessed value. Other states have much lower percentages. Taxable value starts by taking assessed value and adjusts (downward) that assessed value according to tax laws and exemptions. Exemptions are available for veterans, seniors, taxpayers on low-income government assistance programs, to name a few. Each state and even each taxing district can have their own laws and limitations when it comes to property taxes, so it’s best if you do a little research on what those are. A simple google search with your county + state + property taxes can yield a lot of information! After subtracting everything from taxable value, the tax office compares it with any limitations or aforementioned caps. In Iowa, the limit for taxable value growth is 3% for residential property.
Credits – Most states offer some type of credit for people who own and occupy their home for a certain portion of the year. In Iowa, it’s called the homestead credit, and gets subtracted from your gross tax amount due to the state. Other credits are available, so be sure to check with your state. The full list for Iowa credits can be found here.
How are property taxes calculated?
When it’s all said and done, the format of your statement might look something like the one below. Basically you’re starting with the assessed value, then deducting any exemptions to get to taxable value, and finishing it off by factoring in any caps to arrive at gross tax. Once you get there, subtract any credit amounts to end up with your net property taxes.
An example using some easy, round numbers follows (levy=tax rate, is set at 1.6%, an average for my county):
|Assessed Value||Taxable Value|
|Multiply Taxable Value by Levy|
|Equals Gross Tax|
If the lender for your loan set up an escrow account for your mortgage, each month you’ll make an additional payment to cover property taxes. The amount you’re paying is the monthly share of an annual estimate done by your lender, but it’s just that–an estimate–so remember that at the end of the year you may get a refund or have to pay extra to cover the shortfall.Your city isn’t leaving the math to you on this one, they’ll send you the statement with your net taxable amount and a payment stub to remind you when to pay your taxes.
Why does assessed value change?
The second thing to note is that even though there is a nice formula for property taxes, changes in assessed values are continually being made for a number of reasons. I can’t speak for every state, but I’m going to guess the process for adjusting property taxes is largely the same: property is assessed every two years and a process called “equalization” is applied to try and ensure that property values are comparable among jurisdictions.
The strategy for determining property taxes seems rather straightforward in theory, but as hard as the gov might try to equalize and ensure comparability, in reality property taxes can still become random and inconsistent from home to home.
This can be attributed to several reasons outside of the property formula, but the gist of what I’m getting to is that property taxes on a home are the result of several factors, most of which you have no influence on because they’re just past transactions.
Property taxes on a home go up or down largely as a result economic conditions, normal buying and selling, and changes made that impact the value of the home. Some factors and events that can affect your property taxes are as follows:
- the initial assessed value of the home when it was built
- prices at which it has been sold from the time of its construction
- number of times it has been listed and/or sold
- economic condition of the housing market at its sale dates
- assessed value of homes in its proximity
- sale price of homes in its proximity
Basically, all of these factors provide the city with a basis to adjust your property taxes according to what they might imply about the home’s value. As you can imagine, these factors are highly variable and difficult to predict which make property taxes that way, too. You can’t tell just by looking at a house what transactions have happened, you’ll have to check the county or municipal assessor’s page. Be sure to do this before buying a home!
Alright, time for some examples…
Let’s say there are two identical family homes. One home gets sold 6 times over the course of 20 years, another only twice. They may have different property taxes because each time the houses get sold, the city likely adjusted the assessed value of the property, thus increasing the taxes.
Another scenario…it’s 2009, just after the housing market crash and a house gets foreclosed upon, but only after its’ occupants have beaten it up a bit. Someone buys it on the cheap, the assessed value stays low and so do the property taxes. There have been several periods in time where housing prices have gone up or down significantly, which likely had some effect on assessed value and property taxes thereafter.
The city might also increase assessed value if there have been sales of houses in proximity that make the case for the value being higher than what it’s currently assessed at.
Or let’s say you buy a piece of land in a part of town that’s not yet been developed and build a house…your property taxes probably start out very low. Your property taxes will likely go up modestly over a decade or two, making it an affordable place to reside. Fast forward twenty years and you’re in that same house, but you’ve got lots and lots of neighbors as the part of town you’re in has now become one of the best ‘burbs in the area. There are good schools and other desirable qualities for people wanting to start a family. As more homes get built, initial assessed value and property taxes grow, leaving you with
New Money does some research
Last weekend, I took a look at Zillow and conducted a home search for what I think the average “family home” might be for people in my metro area of Des Moines, Iowa. You may not live here, but you know the type of home I’m talking about. Good schools in the vicinity, a decent commute, room for Rover to play and a few extra bedrooms to fill with offspring. Here in Des Moines, I used an estimated home price that’s quite a bit higher than what I could currently afford, but one that I think two adults with well-paying jobs could muster up a payment for each month.
For the sake of the example, I used homes that were recently listed in the price range of $200,000 to $250,000. I tried to find ten or so homes in each city that seemed reasonably comparable were. Keep in mind, these numbers are rounded and the property taxes available are estimates; I’m not trying to win a scholarship for my mathematical accuracy, only trying to show how disparate property taxes can be. The listings are detailed below (if you’d like the actual addresses of the homes I selected, send me an email). They’re sorted by city, then by price so that you can see the fluctuation of property taxes.
|Home number||City||Price (Rounded $)||Taxes ($)||Assessed Value||% Priced Above
|$ Above (Below)
|1||West Des Moines||248,000||3,200||175,000||41.71%||(160)|
|2||West Des Moines||247,000||3,800||209,000||18.18%||440|
|3||West Des Moines||240,000||3,600||182,000||31.87%||240|
|4||West Des Moines||237,000||3,400||188,000||26.06%||40|
|5||West Des Moines||235,000||3,900||210,000||11.90%||540|
|6||West Des Moines||235,000||3,400||189,000||24.34%||40|
|7||West Des Moines||235,000||3,000||192,000||22.40%||(360)|
|8||West Des Moines||232,000||3,900||196,000||18.37%||540|
|9||West Des Moines||220,000||3,300||182,000||20.88%||(60)|
|10||West Des Moines||220,000||3,200||179,000||22.91%||(160)|
|11||West Des Moines||220,000||3,000||169,000||30.18%||(360)|
|12||West Des Moines||217,000||3,900||200,000||8.50%||540|
|13||West Des Moines||215,000||3,200||165,000||30.30%||(160)|
|14||West Des Moines||208,000||2,900||163,000||27.61%||(460)|
|15||West Des Moines||205,000||2,700||147,000||39.46%||(660)|
*Above and below $ this was done by subtracting the home’s property taxes from the average of property taxes of homes I selected in that city. Nothing statistical here.
Naturally, there are TONS of limitations with the very elementary method I selected to compile this list, but I just wanted an idea of what I would be paying for property taxes, in the home price range of $200-250k, in and around Des Moines. The verdict: probably somewhere between $3,000-$4,000.
The biggest point I want to make with this post is that you should be aware of an expense that’s potentially thousands of dollars a year, for the rest of your life (or as long as you own a home). It pays to look and buy accordingly. There’s nothing wrong with paying a lot in property taxes…there’s a good chance you’ll live in a highly desirable neighborhood, just know what you’re paying to live there.
Many people overlook property taxes in their home-buying process, and while it’s not the most important factor, it should still be at least a data point you bring into your decision-making process. Having a little bit of extra cash each month that’s not going out the door to pay a tax is a very good thing. It’s money we can all use elsewhere, and can ease, if only slightly, the burden of a mortgage. Oh the joys of home-ownership.
Keep calm and house-hunt on my friends, just make sure to look at those property taxes!
X’s and O’s
#personalfinance #buyingahome #money #propertytaxes #assessed value #newmoneyrules