Property taxes are the primary source of revenue for local governments in the United States. The money collected from property taxes provides funds for fire protection, law enforcement, public education, road construction, and other public services. History shows that taxes were first levied upon real estate in ancient civilizations, including Egypt, Persia and China. In medieval times, property taxes were assessed based on the size of the real estate parcel owned. This was later modified so that taxes were assessed based on the income producing capacity of the property (including structures, agricultural equipment, and livestock). Today, property tax assessment procedures vary by state, county, and city, as well as zoning within localities. While each local government has its own procedure for assessing and taxing real estate, the general formula for property tax is as follows: Annual Budget – Sales Tax Revenue / State Aid = Property Tax In the past, property tax rates have been relatively stable, with only mild fluctuations. As property appreciates in value, local taxing authorities (using the same tax rate) are able to collect more revenue based on higher assessed values. However, with the marked decline in property values and the need for local revenue (to maintain adequate public services), property tax rates are on the rise. Additionally important to remember is that the assessed value and the appraisal value of your property are determined by different entities and are rarely in concurrence. In assessing the value of real estate for property tax purposes, there are 3 standard approaches that are employed. These include the following:
- Cost Approach ― The estimated value of the land, without improvements, is determined. The replacement or reproduction value of improvements to the property (e.g., home, pool, or patio), less the accrued depreciation of said improvements, is then added to determine an assessed value.
- Sales Comparison Approach ― The sales price of comparable homes in the area are averaged to determine the assessed value of the property.
- Income Approach ― For income-producing properties (such as a lease or rental property), a mathematical process called “capitalization” is used. The estimated income of the particular property is a variable in the formula, enabling the calculation of the assessed value for property tax purposes.
The simplest approach tends to be the “sales comparison approach,” however; it is not necessarily the most accurate. The “cost approach” is much more involved and takes into account a myriad of factors because specific improvements are identified in enough detail to determine reproduction costs ― these can include materials to construct the foundation, construction of structural and finish walls, roofing, heat and/or air conditioning, types of appliances, septic system, whether water is supplied by well or public utilities, the condition and age of the improvements, and more. How often property is reassessed varies from state to state. Remember, property taxes are not based on the purchase price of a home, but on the assessed value of the property.