How Property Taxes Work

Home buying can be both exciting and stressful. After all, there are so many factors that impact your decision, from the liveliness of a neighborhood to the quality of a local school district. But, an area’s affordability usually ranks among a home buyer’s most pressing concerns.

When estimating the total cost of living of a home in a given area, there’s more to consider than the mortgage. Don’t forget about property taxes, that annual fee you’ll be paying as long as you own the property. Even if the price may seem manageable on paper, sizable property taxes could cut into your disposable income more than you might initially expect.

HOW PROPERTY TAXES WORK

While the specific property taxes you face might differ significantly by local market, there are some general similarities that anyone looking to buy a home should understand. That way, you might be able to find an effective way to minimize your property tax burden.

HOW PROPERTY TAX IS CALCULATED

Property tax is calculated as a percentage of the appraised monetary value of a piece of property. It is collected by state and local governments in the United States and most property tax receipts go towards funding public services such as education, law enforcement, and local infrastructure.

The property tax rate (sometimes referred to as the “millage rate”) is determined by local governments. A municipality will hire a tax assessor to estimate the current market value of a property. Property tax is then applied only on the assessed value, not on the purchase price.

Property tax is usually applied only on real property, although personal property can sometimes be subject to property tax as well. Real property is defined as land and buildings, while personal property includes items like cars and boats that might occupy the real property.

Imagine that you live in an area with a 2% property tax rate on real property. Following a real estate appraisal of $100,000, you will then face $2,000 in annual property taxes, calculated by multiplying the 2% property tax rate on the $100,000 assessed property value.

Now imagine there is a property tax increase from 2% to 2.5% in your municipality. Assuming no change in the appraisal value of your property, your property taxes will now jump to $2,500. If the appraisal on your property simultaneously comes in higher at $110,000, you would now face a property tax burden of $2,750.

It’s important to pay attention to the expected future value of a property you might be looking to purchase as well as the property tax rates of that area. And, if current urban housing trends are any indication, expect those taxes to only increase when purchasing property in one of the cities with the fastest rising real estate prices in the U.S. This means that while the estimated current market value of the property may increase, you will have to shoulder a heavier property tax burden in the meantime.

PROPERTY TAX FORECASTING TRENDS FOR 2019

The Tax Foundation recently released their 2019 State Business Tax Climate Index and has provided separate property tax analysis, which is an intuitive way to see how your state compares to others over the last few years. Heading into 2019, states like Arkansas, North Dakota, Oklahoma and Wyoming have fallen in the property tax rankings, while Alaska and Delaware gained a whopping fifteen and eleven places respectively from 2018.

With that said, North Dakota still ranks 6th amongst all 50 states, so it’s important to consider the absolute rank of each state in addition to its year-over-year change. For those looking for detailed property tax information across the entire U.S., the Lincoln Institute has published an expansive study comparing property taxes across all states in 2017.

So, when estimating the cost of purchasing a new home, don’t forget to factor in property taxes as an unavoidable recurring expense. To do so, you must understand how property taxes work and what to look for when evaluating the affordability of a neighborhood.

No matter what the price tag of your new home, understanding property taxes, and how they might fluctuate year over year, is the surest way to keeping your finances firmly under control.