What Are Property Taxes?
When you buy a home, you'll need to factor in property taxes as an ongoing cost. It’s an expense that doesn’t go away over time and generally increases as your home appreciates in value.
What you pay isn’t regulated by the federal government. Instead, it’s based on state and county tax levies. Therefore, your property tax liability depends on where you live and the value of your property.
In some areas of the country, your annual property tax bill may be less than one month’s mortgage payment. In other places, it can be as high as three to four times your monthly mortgage costs. With property taxes being so variable and location-dependent, you’ll want to take them into account when you’re deciding on where to live. Many areas with high property taxes have great amenities, such as good schools and public programs, but you’ll need to have room in your budget for the taxes if you want to live there.
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How Are Property Taxes Levied?
Property taxes are levied on real estate by governments, typically on the state, county and local levels. Property taxes are one of the oldest forms of taxation. In fact, the earliest known record of property taxes dates back to the 6th century B.C. In the U.S., property taxes predate even income taxes. While some states don't levy an income tax, all states, as well as Washington, D.C., have property taxes.
For state and local governments, property taxes are necessary to function. They account for most of the revenue needed to fund infrastructure, public safety and public schools, not to mention the county government itself.
You may have noticed already that the highest-ranked public schools are typically in municipalities with high home values and high property taxes. While some states provide state funds for county projects, other states leave counties to levy and use taxes fully at their discretion. For the latter group, this means funding all county services through property taxes.
To get an idea of where your property tax money might go, take a look at the breakdown of property taxes in Avondale, Arizona.
You can see that Maricopa County takes a cut, as do local school districts and colleges, the library and the fire department. While this shows a specific example, you may not find the same breakdown of tax levies where you live. Your property tax bill often depends on county budgets, school district budget votes and other variable factors that are distinct to where you own property.
How Property Taxes Are Assessed and Calculated
Property tax is assessed through an assessment ratio. This is the ratio of the home value as determined by an official appraisal (usually completed by a county assessor) and the value as determined by the market.
As an example, if the assessed value of your home is $200,000, but the market value is $250,000, then the assessment ratio is 80% (200,000/250,000). The market value of your home multiplied by the assessment ratio in your area equals the assessed value of your property for tax purposes.
The assessment of your property will depend on your county’s practices. But it’s common for appraisals to occur once a year, once every five years or somewhere in between.
The process can sometimes get complicated. In a few states, your assessed value is equal to the current market rate of your home. The assessor determines this by comparing recent sales of homes similar to yours. In other states, your assessed value is thousands less than the market value. Almost every county government explains how property taxes work within its boundaries, and you can find more information either in person or via your local government’s website.
Another crucial term to understand is millage rates. The millage rate is the amount per $1,000 of assessed value that's levied in taxes. Millage rates are expressed in 10ths of a penny, meaning one mill is $0.001. For example, on a $300,000 home, a millage rate of $0.003 will equal $900 in taxes owed ($0.003 x $300,000 assessed value = $900).
To put it all together, take your assessed value and subtract any applicable exemptions for which you're eligible and you get the taxable value of your property.
That taxable value then gets multiplied by the sum of all applicable millage rates. All the separate tax levies are added and then applied to your taxable value. The number you calculate (millage multiplied by taxable value) tells you the property taxes owed before any credits. Note that tax credits are different from exemptions and aren’t universally available. You’ll have to check with your county to see if you’re eligible for any.
These credits are subtracted from any taxes you might owe. Once you find that number, you have your total property tax bill.
How you pay your property taxes varies from place to place. Some people pay extra each month to their mortgage lender. The lender keeps that money in escrow and then pays the government on behalf of the homeowner. Other people pay their property tax bill directly to the county government on a monthly, quarterly, semi-annual or annual basis. Your payment schedule will depend on how your county collects taxes.
What Property Tax Exemptions Are Available?
Here's a breakdown of four common property tax exemptions:
- Homestead: This exemption can help homeowners reduce state property taxes and protect surviving spouses from creditors. Rules and protection limits can vary by state. The exemption can only be applied to a primary residence.
- Persons with disabilities: Qualifying disabled homeowners can reduce property taxes on a legal residence. Local governments and school districts offer partial exemptions.
- Senior citizens: Local governments or school districts can offer property tax reductions to qualifying seniors. These are usually limited to primary residences.
- Veterans/Disabled veterans: Veterans can qualify for property tax exemptions from their state, county and city. How much they get can also depend on disability rating.
Most states and counties include certain property tax exemptions beyond the full exemptions granted to religious or nonprofit groups. These specialized exemptions are usually a reduction of up to 50% of taxable value. However, rates vary by location.
Some states offer exemptions structured as an automatic reduction without any participation by the homeowner if your property is your primary residence. Other states and counties require applications and proof for specific exemptions. This is the case for homeowners claiming exemptions as disabled veterans.
For a closer look, let's break down how much you could get with a homestead exemption. As we stated earlier, this exemption safeguards a surviving spouse and protects the value of a home from property taxes and creditors in the event a homeowner dies.
Say your state offers a homestead exemption for a homeowner’s primary residence that offers a 50% reduction of the home's taxable value.
This means that if your home was assessed at $150,000, and you qualified for an exemption of 50%, your taxable home value would become $75,000. The millage rates would apply to that reduced number, rather than the full assessed value.
It’s worth spending some time researching whether you qualify for any applicable exemptions in your area. If you do, you can save thousands over the years.
Property Taxes by State
Overall, homeowners pay the most property taxes in New Jersey, which has some of the highest effective tax rates in the country. The state’s average effective rate is 2.47% of a home's value, compared to the national average of 1.02%.
With an average effective rate of 0.29%, the least expensive state for property taxes is Hawaii, surprisingly. Despite its reputation as a costly place to live, Hawaii has generous homeowners exemptions for primary residents that lower taxable values considerably. The tax break generally helps those who live in Hawaii full-time, rather than those who own a second home there.
Also of note are Colorado and Oregon’s property tax laws, which voters put in place to limit large taxable value increases. Many states don’t have caps on how much property taxes can change annually, but those two are examples of state governments that put laws in place because of taxpayer concern.
