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How Do Property Taxes Work Anyway? A Full Guide

November 06 2018
by Leisl Bailey

Tax bill with calculator, glasses, and pen on white desk with keyboard. Find out how do property taxes work at Clever Real Estate.

Property tax calculations can be one of the most difficult parts of being a homeowner. This is because state and local governments throughout the country do not always follow the same set of calculations. Although their math is typically similar, it is just different enough to be tricky.

But you don’t need to worry! We’re here to help. We’re going to walk you through why you pay property taxes, how they work, and how to find out how much you owe.

What are property taxes?

Property taxes are an annual ad valorem tax that all homeowners must pay for the benefit of their community. If you didn’t study Latin in school, you’ll need to know that ad valorem is a Latin phrase that means “according to value.” So, your local government calculates the cost of your property taxes based on the value of your property.

For example, if you just own a piece of “raw land,” i.e., a lot with no structure or utilities, the taxes will be very low. If that same land has access to public services like a sewer line, water, and gas, the taxes will be higher. Once you put a house on the lot, taxes will go up yet again.

This is why it is so important to understand property taxes. This way, you can understand the process behind the calculations and ensure you are not getting overcharged.

Here are a few examples of property taxes by state:

State Effective Real-Estate Tax Rate Annual Taxes on $185K Home* State Median Home Value Annual Taxes on Home Priced at State Median Value
Hawaii 0.27% $501 $538,400 $1,459
Washington 1.06% $1,962 $269,300 $2,860
Texas 1.86% $3,435 $142,700 $2,654
New Jersey 2.40% $4,437 $316,400 $7,601

How do property taxes work?

Your local tax assessor’s office determines the amount of property taxes that you need to pay each year. Property tax rates are based on the assessed value of your home. These assessments can be done as often as once a year or as rarely as once every five years.

The assessment schedule completely depends on the laws of the states and localities; however, the process is always the same.

First, you should receive a letter stating the assessed value of your home. After that, you will get your bill.

Here is how the state determines the assessed value of your home:

Sales Comparison Method

In this method, the tax assessor compares your home to other very similar homes that have recently sold nearby. The assessor makes sure to only compare your home to similar ones, meaning they will not compare a shotgun house to a two-story ranch house.

They will also take into account things like location (if it’s near schools or highways, etc.) and renovations that could increase the value of your personal property.

The Cost Method

When using the cost method, a home assessor calculates how much it would cost to make an exact copy of your home on the current land. They will consider parts and labor as well. If your home is older, they will factor in the age of your home, and then add in the value of the land itself.

The Income Method

The income method is usually applied to commercial or business properties, but it is not an income tax. However, it can often be used for rental properties as they are considered businesses.

In this method, the assessor assigns a value to the property based on the projected amount of income available to be earned. They base this number on things like costs of maintenance, insurance expenses, and prevailing rental rates.

The next step is to multiply your home’s assessed value by the local property tax rate. This rate is sometimes called a millage rate or mill rate.

Before we explain mill rates, we will say this: It is possible to appeal the assessed value of your home if you do not agree with it. If you want to appeal your property tax bill, you will first need to do a little bit of investigative reporting.

You will need to hire your own home assessor and their findings should be significantly different than those of the tax office. If this is the case, then you can submit an official appeal.

What’s a mill?

One “mill” equals one-tenth of one cent. Another way to think about it is $1 for every $1,000 of a certain property’s value. Different local governments can charge varying mill rates. It is highly unlikely that your property taxes are based on just one “mill.”

Each year, a taxing authority might determine how much tax revenue it needs to stay “in the black” for that year. The council can then set that year’s mill rate to ensure they can collect that amount of money through property taxation.

Let’s say your home has an assessed value of $150,000, and your local mill rate is 50. All you have to do is multiply your property’s value by 5 percent to see how much property tax you will pay in any given year. So in this example, you would pay $7,500 in tax. If your mill rate was only 1.5, then you would pay $2,250 on the same house.

Exemptions to Property Taxes

There are sometimes exemptions when you pay property taxes. The main exemption is called the Homestead Exemption. This is a law put in place to protect the survivor in case of the death of a spouse.

Homestead Exemption laws are designed and defined by these four things:

  • They prevent the forced sale of a home. This means you don’t have to sell immediately to meet the demands of creditors, usually mortgages, mechanics liens, or pay property taxes.
  • They provide the surviving spouse with a safe place to live.
  • They offer an exemption from property taxes on a home. (However, it is important to note that a homestead exemption is usually only a fixed monetary amount, like the first $50,000 or so of the assessed value and not the whole thing.)
  • They allow a tax-exempt homeowner to vote on property tax increases to homeowners over the threshold, by bond or millage requests.

What are property taxes used for?

School districts, fire departments, and libraries are three of the main beneficiaries of property taxes. Property taxes are often a major source of funding for your city and county.

The powers that be use the money to keep things running smoothly and keep certain amenities functional and open to the public. Sometimes, property tax bills show details on what exactly your money is being used for.

How to Pay Property Taxes

In the states that charge a property tax, you pay your annual fee directly to the state governing board that is in charge of collecting taxes. Typically, this office is the State Comptroller or the Department of Revenue.

For a complete list of each state’s property tax governing board, see this list from the IRS and select the state where you own property.

As for how to pay, you receive your property tax bill in the mail and you pay it. That’s it. There is no third party or middleman involved.

Sometimes when you have a mortgage on your house, it works a little differently. Sometimes, lenders will roll a homeowner’s property taxes into their monthly mortgage payments and then charge them extra each month. Many private lenders are not required to do this. But if you are using an FHA loan for your mortgage, then the agency requires this payment plan.

FHA Taxes

The FHA needs to protect itself in case of payer default. To avoid being responsible for an entire year’s worth of taxes should the borrower become unable to pay, the Federal Housing Administration does this instead:

It calculates a homeowner’s annual tax rate and divides it by 12, causing them to pay a prorated rate out each month. If somehow the calculations were incorrect, the homeowner will either receive a refund at the end of the year (sometimes in the form of a tax credit) from the FHA, or make an extra payment to the agency.

These families might also receive a Property Tax Circuit Breaker, which is a refund for the government for families whose property taxes are a significant amount of their yearly income.

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Ready to buy or sell a home, but need a little help with your property taxes? No worries! The team at Clever deals with taxes every day and can help you estimate what the taxes will be on the home of your dreams. Call us today at  1-833-2-CLEVER or fill out our online form to get started.