Property Taxes Explained

If you own a home, property taxes are usually a large part of your monthly mortgage payment.  While politicians like to talk about lowering property taxes, in most towns across the nation, this tax increases almost every year.

Property Taxes and Essential Services

It's easy to explain why politicians promise lower property taxes; most homeowners and businesses don't like paying higher taxes.  But those same businesses and homeowners value the services real estate taxes provide to their business or community.

To further explain this concept, let's take a quick look at the types of services this tax pays for each year.  We'll also look at how these taxes are calculated, and what a typical property tax bill might look like.

State and Local Income and Expenses

One of the services the U.S. Census Bureau provides us with is a picture of where state and local governments get their revenues, and how that money is spent.  The following two tables give us a better understanding of the average sources of income and expenses for state and local governments.  All of this data is based on information gathered in the year 2000:

Sources of State and Local Income

The following list shows the various sources of local and state revenues, which are then used to provide essential services to their citizens:

• Real Estate / Property Taxes 32%
• Gross Receipts (Tax on Utilities) / General Sales Tax 25%
• Individual Income Taxes 22%
• Motor / Fuel Sales Tax 4%
• Corporate Income Taxes 3%
• Motor Vehicle Licenses 2%
• Alcoholic Beverages 1%
• Tobacco Sales Tax 1%
• All Other 10%

State and Local Expenses

This second list shows the various expenses incurred by state and local government.  These are the essential services provided:

• Education 30%
• Social Services 21%
• Public Safety 8%
• Transportation 7%
• Insurance Trusts 7%
• Utilities 7%
• Environment and Housing 7%
• General Expenditures 5%
• Government Administration 4%
• Interest on Debt 4%

From the above two tables, we can see that property taxes, or real estate taxes, are the single largest source of funding for state and local governments, and most of the money pays for education, social programs, and public safety.

Property Tax Calculations

Property tax is what is termed an ad valorem tax.  That's a fancy way of saying the tax is based on the value of the property itself.  For example, two homeowners in the same township with homes of equal value should pay the same amount of property tax each year. 

Using the same logic, someone owning more valuable property would pay more property taxes.  The important point to understand here is that property taxes are based on property value, not how much you earn or spend each year.  That's one of the big differences between property taxes and income taxes.

Property Tax Formula

The basic property tax formula is very much the same across the country, and takes the following form:

Taxable Value x Tax or Levy Rate = Annual Property Tax Bill

Taxable Value

The taxable value for a typical home would include the land and the structure, or home, itself.  This is also referred to as the land and improvements.  At times, the value of the improvement (or home) is depreciated or stated at a specific point in time (original cost).  Land is never depreciated.

This original cost or depreciation concept means that a brand new home selling for $300,000 may owe more property taxes than an older home that has the same market value.  The rationale is that the home is new, and therefore has more value, than the older home even though the market price might be the same.

Tax or Levy Rate

The challenge for a township then becomes one of making sure they collect enough property taxes to pay for all of the services they need to provide in a given year.  The tax collector would first take a look at the township's total approved expenditures for a calendar year.  Next they would add up all of the taxable values for the properties in their township.

With these two pieces of information, a proposed Tax or Levy Rate can be calculated:

Tax or Levy Rate = Total Township Expenditures / Total Taxable Value

When examining the formula, it becomes evident that comparing the levy rate from town to town is meaningless.  That's because each town might figure out their Total Taxable Value in a slightly different manner, thereby changing the required tax rate.

Property Tax Reassessment

Many taxpayers are confused, and concerned, when it comes to planned property tax reassessments.  They are unsure if their property taxes are going to increase or decrease, and they're confused over what happens to the tax rate.

Reassessing Taxes

During a reassessment, the town's tax collector, or tax assessment agency, reevaluates the value of all properties in the township.  In most situations, homes are valued at or near their true market value.  This new valuation normally increases the town's total taxable value.

If you own a relatively old home, then your assessed value would tend to move higher than a newer home that might be assessed closer to its market value.  There are three elements that help to explain why this happens during a reassessment:

• The tax rate formula itself.
• There is normally an increase in Total Taxable Value (the denominator).
• Older homes will be currently assessed at values that are further from their true market value than newer homes.

These three pieces of information can help us draw some conclusions as to what happens during a reassessment.

Reassessment Rules

The following generalizations can be made when trying to figure out the impact of a reassessment on an individual homeowner:

• If a reassessment results in a larger Total Taxable Value (or base) for a township, then the Tax or Levy Rate would also decrease.
• Property taxes will increase for older homes that are assessed at values further from their true market value and consequently reassessed at values closer to true market value.
• Property taxes will decrease for newer homes that are already assessed closer to market value.

In general, homeowners with older homes tend to be the "loser" during a reassessment, and wind up paying a larger share of property taxes.  Homeowners with newer homes tend to be the "winners" during a reassessment and wind up paying a smaller share of the town's real estate tax bill.  The above example assumes there is no need to collect more taxes, only reassess who pays what share of those taxes.

Annual Property Tax Bills

Most municipalities like to show its residents where their property taxes are going, and what better place to show this information then on the tax bill?  We're going to explain what you'd likely find on a typical tax bill.  What actually appears on your bill will vary from town to town.  Generally, the property tax bill is broken down into two or three sections:  expenses, taxable value, and total bill.

Property Tax Bill Expenses

The first item most property tax bills will outline is how the money is allocated to various services.  This means you will see your share of the township's expenses.  This will include money paid to the state, local schools, county government, fire, police, library, sewer, and water (if included in your property taxes).

This is usually stated as the property owner's share of these expenses, and might look something like this on your bill:

Example Property Tax Expenses

Property Tax Total Value

As mentioned earlier, the next calculation usually performed on a property tax bill is the determination of your taxable value.  This is where some property owners take exception to their property tax bill.  They disagree with the taxable or assessed value.  An example of this section might look like the following:

Assessed Property Value Example

Total Property Tax Bill

The final step shown on your tax bill will be the reconciliation of the expenses to the tax bill.  If you were following our earlier example, this means your Taxable Value is multiplied by the Tax or Levy Rate to equal the money owned in the coming year.  There may be other adjustments or a credit to your bill, but the rule is basically the same:  income must equal expense for the township.

Example Property Tax Bill

The fact that the property tax bill is exactly equal to the current expense is no accident.  The factor called the levy tax rate made sure the two sides of this equation are equal.

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