The term “real estate tax” can mean many things to different people. Some may only know what property taxes are, while others might associate real estate taxes more closely with mortgage interest rates or home value limits.
In fact, there are several types of real estate taxation in most major cities across America! These include:
Property tax – this is probably the least familiar type to most individuals. A property tax is an annual fee paid directly by you as the owner of a house or apartment. This is typically determined by two factors: your residence address and average housing price per area.
Housing excise tax – also known as capital gains tax, this is done at a state level and depends on whether or not you reside within the city for a given period of time. For example, if you live in California but work outside of the state, then your residency does not qualify you for the same rate of income tax. However, if you spend more than 90 days outside of California, then you would be taxed at a higher rate due to your longer stay.
Business license tax -this one is pretty straightforward- any business that is operated from your home will need to have a business license! Most municipalities require you to pay this yearly or monthly depending on how much revenue the business generates.
These three examples alone should make it clear that owning a home comes with its own set of responsibilities.
What is the state tax rate?
The state tax rate for real estate varies by state. Some states have only one tax, while others have several. Most of these taxes are referred to as property taxes or income tax depending on what type of taxpayer you are.
Some examples of this include:
In California, there is both an annual personal income tax and a yearly parcel transaction tax that get added onto your property tax bill.
In Florida, there is an annual individual income tax and a yearly business franchise tax that gets tacked onto your property tax bill. A business franchise can be anything from owning a restaurant to being a dentist!
In Texas, there is no personal income tax but they do have a gross production tax that gets taxed at each transfer of ownership. This includes buying or selling a house.
What most people don’t realize about property taxes is that it is not just the total amount that matters, it is how much of a difference it makes in paying your monthly bills. Let us look at some numbers as proof.
Say you own a home worth $100,000 with a mortgage payment of $1,500 per month. Your taxable home value would be half a million dollars because the IRS considers the cost to buy the home as well as any improvements you make to it part of its sale price.
But now assume we doubled the price of your home to create a new, more expensive home.
How are property tax rates determined?
The next level in understanding how real estate taxes work is figuring out what your tax rate is. This is also the most confusing part of paying real estate taxes as there are so many ways to determine it!
Most states have two different methods for calculating property tax rates. Some use an equalization method, while others use a direct calculation method.
The easiest way to understand this is by example. Let’s say you own a home that is worth $100,000. You pay $1,500 per month in rent, which equals a monthly income of $18,000. Your personal net income is $6,000 a year (six thousand dollars a year!).
Your annual rental income ($18,000) exceeds your yearly personal net income($6,000), so you make more than enough money to be considered rich. However, owning a house is not very practical at the moment, so let’s look at how much you would need to earn to justify buying a house instead of renting one.
A lot of people recommend being able to afford a mortgage payment and extra savings in order to just buy a place instead of renting. Luckily for you, we found some numbers!
According to Zillow, the average person in America spends 6% of their income on housing costs.
What is the impact of property tax rates on property values?
The higher the property tax rate, the lower the value of your home. This is because people will avoid paying as much in taxes to reside in their homes, thus devaluing the properties next door that are not protected from high taxes.
People also have different definitions of what it means to live in a wealthy area. If someone lives two blocks away from the school with the best education opportunities for their children, they may consider themselves living in an affluent neighborhood even if there is no expensive restaurant within walking distance or a private pool.
Another reason why property taxes play a big part in determining how rich or poor you feel like perusing real estate is due to the fact that most cities use the same taxing system. Wealthy homeowners in more popular areas can pay less than average income earners in less crowded neighborhoods.
This article will go into greater detail about this but overall, higher property taxes mean that your house is worth less.
What is the impact of property tax rates on renters?
As mentioned before, one important factor in determining how much your rent costs is the yearly cost to live at your residence and pay additional money in taxes. This includes both personal property and real estate taxes.
Most states have a board that handles all property taxation, including both personal and business properties. These boards are made up of individuals with various levels of experience so they can agree on who gets what classed as which category an asset falls into.
There are many factors that determine this, such as if it’s used for income or not, but beyond that it depends on the individual assessors’ definitions of what constitutes personal use vs. business use. Some define using the house for sleepovers or going away parties as non-business uses while others may disagree.
Another major component comes down to how much revenue the state receives per unit from these assessments. States that get more income per person assessed will receive proportionally less money per person due to lower incomes, thus making homes more expensive. The wealthier people move out of the area, the fewer revenues are collected, making houses even pricier!
This article/blog post has discussed some of the main reasons why rental prices are rising, and this article focused on property taxes being a significant contributor. Make sure you read the rest of the articles in the series to understand other causes of rental price rises.
What is the impact of property tax rates on buyers?
When it comes to real estate taxes, what people may not realize is how they are calculated. The one thing that most people will find surprising about property tax calculations is that it is more than just your yearly bill!
Most states calculate an annual “roll up” tax on all properties in the area you live in, as well as any other areas where you own land or a house. This roll-up tax is then multiplied by each parcel’s value to determine your personal property tax liability for the year.
The easier way to look at this is that your home is paying for part of the education costs for the children in your neighborhood!
Now, some counties only assess the roll up tax once per year, but many do every six months. That can make a big difference in how much you pay each month!
By calculating the roll up tax monthly rather than annually, there is less chance of missing a deadline and having to pay penalties. Plus, it gives individuals time to update their property records which may reduce their individual liability slightly. If you’re thinking about selling your current residence, now might be a good time to do so!
I have provided links below to resources that can help you understand your property tax situation more in depth.
What are the differences between capital gains and capitalized income?
The term “capital gain” is typically used to describe any increase in the value of your property that occurs because you either sold it or reduced its price.
A capital gain happens when an asset (like real estate) increases in value and you, as the owner, get a proportionate share of this growth. For example, if you buy a house for $100,000 and it later rises to $150,000, you make a $50,000 profit – a $10,000 capital gain.
However, not all events qualify as a capital gain. One situation where this isn’t true is when an individual reduces the price of an investment property.
For instance, let’s say that you own a house that costs $250,000. You can never sell it for less than $200,000 so it makes no sense to reduce its cost below that amount. Therefore, it cannot be considered a capital loss like owning a house for $20,000!
The difference between a capital gain and a capital loss depends on what type of income you have. If the money you made from the sale was spent on other things then it doesn’t count as income and therefore isn’t taxed. This is called non-taxable spending.
By contrast, if the money you received was put into savings or invested in assets such as shares then it counts as taxable income.
What is the impact of capital gains and income on tax bills?
As mentioned before, when you sell a house, there are two main components to your taxes: state property sales tax and federal income tax. The former depends on how much state and local revenue the house generates for your area, while the latter is determined by what category your new residence falls into in terms of income.
When it comes time to figure out how much money you make enough to pay higher than average taxes, it helps to know which types of homes cost more and why!
Here we will look at some examples that illustrate this.
What is the definition of a capital loss?
A capital loss occurs when you sell an asset for less than its cost. Your taxable income will be adjusted because there was a large decrease in equity (the difference between what you sold it for and how much you paid to purchase it).
If your business includes renting or owning real estate, understanding how property taxes are calculated can help determine if you have a deductible expense.
Most people who buy or rent a home include the property tax in their monthly mortgage payment or rental fee, respectively. This means that even though they may not pay the exact amount shown on their yearly tax return, they still deduct this expense from their personal income.
How these deductions work depends on whether you’re buying or selling a house. If you’re moving away, you can usually exclude the previous year’s property tax bill since you won’t own it anymore.
But if you’re staying put, you must add back in the old debt so your net worth isn’t negatively impacted.