Understanding Your Tax Bill: Property, Sales Tax, and How to Avoid Sticker Shock
“The power of taxing people and their property is essential to the very existence of government.”
-James Madison, U.S. President
Whether you aspire to build a real estate empire on Park Place and Boardwalk, or just a modest little home somewhere around, say, Baltic Avenue, there’s no avoiding the tax bill. Both on the Monopoly board and in life, paying taxes can feel like the worst part of the game.
Understanding your property tax bill, and how goods and services can be taxed, may help reduce your risk of sticker shock and may help determine if you’re paying too much. In this post, I’ll first break down the ins and outs of property taxes, and then cover some finer points on sales tax.
If you’ve never bought a home but plan to, you’re in luck. I have some information that might help you understand what you’re getting yourself into! If you have bought a home, you will probably be able to relate to a lot of what I say in this post, and hopefully, learn a few things you didn’t know that could lower your property tax bill. And if you’ve been dying to know about how sales tax differs from state to state, I have a few interesting things to share about that too.
I’m quite familiar with property tax because I’ve paid a fair bit of it over the years (like the Farmer’s Insurance guy who says, “We know a thing or two because we’ve seen a thing or two.”).
Anyway, I was a tad confused when reading about property tax to come across the terms property tax, real estate tax, and personal property tax. I wondered, are they all the same thing?
You may be confused, too. So first, a definition:
People often use the terms property tax and real estate tax interchangeably. By definition, real estate tax is a property tax. However, not all property taxes are real estate taxes. So here’s the difference:
Real estate tax (i.e., tax on “real property”) is charged on immovable property—land and structures that are permanently attached to it such as a house or other building. On the other hand, personal property tax (i.e., tax on “tangible property”) is an annual tax imposed on movable assets—mobile homes, RVs, vehicles, boats, planes, etc. Real estate taxes are taxes on real property only; property taxes can include both real property and tangible personal property. Got it? If you’re still confused, no worries. I’m only going to talk about property taxes as they apply to a home you own and live in. (But just so you know, forty-three states tax tangible personal property.)
Property tax is usually imposed by local governments and charged on a recurring basis. For example, homeowners will generally pay their property taxes either once a year or as a monthly fee as part of their mortgage payments.
Property taxes are fundamentally regressive because, if two individuals in the same tax jurisdiction live in properties with the same values, they should pay the same amount of property tax, regardless of their incomes. However, they are not purely regressive in practice because they are based on the value of the property, which can fluctuate based upon a jurisdiction’s assessment of the worth of a property.
An assessor will evaluate a property using one or more methods: looking at what comparable properties are selling for under the current market conditions (sales method), how much the replacement costs for the property would be (cost method), and any income the owner is making from the property (income method).
California has a unique tax provision that puts a limit on how much any homeowner’s assessed value for property tax purposes can increase from year to year. Proposition 13 imposes a 2% maximum increase on assessed value (with the exception of new construction on the property, which can raise the assessed value beyond the 2% limit). However, when someone sells a home, the new owner can often see a big jump in assessed value and therefore pay higher property taxes, because the Proposition 13 limit artificially deflated the true value of the home.
In the United States, property tax is levied by the local, not the federal government. State governments levy 3% of the total property tax collected and the other 97% is collected by counties, municipalities, schools, community colleges, and many other special-purpose governmental agencies (e.g. libraries, museums, parks, bridge authorities). Rates vary across the states, between about 0% and 4% of the home’s assessed value. The assessment is made up of two components—the improvement value (i.e., the building) and the site value (i.e., the land). The property tax is the main tax supporting local education, police, fire protection, government, roads, and most infrastructure ( e.g. sewers, bridges, street lights).
The amount of property tax apportioned to various recipients can change. Local school districts often take the biggest bite from property taxes (50% of my property taxes go towards paying for schools). If residents of a community have voted to increase the millage rate (the amount per $1,000 that is used to calculate taxes) for a school system, homeowners could see an increase in the tax levied on their properties. Conversely, if property values have fallen due to adverse economic circumstances, property taxes may decrease.
Property tax assessments are not always based on accurate information.
You may assume that when you get a property tax bill, you should pay it and move on. This is what I used to do. But then I learned that property tax assessments are not always based on accurate information. To make sure you are not being overcharged on property taxes, it is imperative to understand the calculations used by the property appraiser’s office in your community.
Are you paying too much?
If you feel you are paying too much, do a little research. Property taxes are calculated using two very important figures—the tax rate (also known as millage or mill rate) and the assessed value of your home. Note: “market value” is the estimated amount active buyers would currently be willing to pay for your home and is only one figure used by an assessor to determine a home’s “assessed value.” An assessor (who may or may not come to your property) estimates the value of your property, which leads to your property’s “assessment.” Your tax bill is calculated by multiplying the tax rate by the assessed value. So, if your property is assessed at $500,000 and your local government sets your tax rate at 2.5%, your annual tax bill will be $12,500.
Tax levies for each tax jurisdiction in an area are calculated separately; then, all the levies are added together to determine the total mill rate for an entire region. Generally, city, county, and school districts each have the power to levy taxes against the properties within their boundaries.
You can get a summary of your property’s assessment from your city or local assessor’s office. This information is a public record. If you note any discrepancies, you can point these out to the assessor and she will either make the correction and/or conduct a re-evaluation. You might be surprised to learn, as was I, that mistakes are common.
Personal note (and how to assess your assessor):
When I bought my current home in August of 2018, the current assessment was $635,600. Since I only paid $580,000 for the house, I didn’t think that assessment was fair. To understand why there was such a big discrepancy between the assessment and the sale price, you need to know about the history of the home’s sell price and tax assessment. In 2006, at the height of the housing boom, the house sold for $705,000 and subsequently assessed at $695,000. Then the housing bubble burst. The value of homes, including mine, decreased dramatically after the housing crash. My home’s assessment gradually decreased to $635,000, but not to the point of 2018 market value.
According to my city’s assessment office, homes are assessed after sale or after acquiring a building permit, but otherwise every 5-10 years. A homeowner can request an assessment at any time, but most don’t because doing so would usually result in an increased assessment. When I bought my home, the sale triggered a reassessment.
When the assessor came to my home, I learned a lot by walking with and talking to her. For example, brick homes are assessed higher than those with wood siding. My house has brick in the front but most of it is wood siding. However, the assessor’s records showed that it was all brick. She corrected that. When I pointed out that the finishings in the non-master bathroom and throughout the basement were of lower grade than finishes elsewhere in the house, she wrote that down. She also noted several other findings that would influence my home’s assessed value. Finally, she told me that it was very helpful to be able to tour the home with me and that many people don’t let the assessor inside the home.
Things that the assessor verified included build year, remodeling year, square footage (finished versus unfinished), number of rooms, exterior walls, roof type (e.g., asphalt shingles, slate, etc.), type and age of heating and cooling systems, number of bathrooms (full and partial), fireplaces, size of garage, and open versus screened porch. She then gave my home a grade of A-.
My property tax bill for 2018 was mailed out in December 2018, so the reassessment didn’t affect my first tax bill. I received my reassessment in April 2019 (for my 2019 tax bill) and it was decreased to $574,900 (less than the sale price – yay!). The assessment is only one part of how a tax bill is calculated (the other is the mill rate) but it’s a very important piece. The change in my home’s assessment lead to a decrease in my property tax from $14,608 (2018) to $13,224 (2019). That’s a decrease of $1,384.
Property taxes tend to increase over time. You will never be free from property taxes while you own your home, but there are a few things you can do to lower your property’s assessment and/or property tax bill:
Any structural improvements you make to your home will increase your tax bill. You might want to think twice before adding a deck, a pool, a large shed, or any other permanent fixture that will increase your home’s value.
Although tax assessors follow guidelines, their assessment still contains a certain amount of subjectivity. This means more attractive homes often receive a higher assessed value than comparable houses that are less physically appealing. You will know in advance when an assessor is coming to your home. You may want to delay any physical improvements or cosmetic alterations (e.g., new wood flooring or stainless steel appliances) until after the assessor finishes the evaluation.
What’s in the neighborhood
Property assessments are public knowledge. You can find out how similar nearby homes are assessed, and compare that with your home’s assessment. For example, let’s say you have a five-bedroom home with a three-car garage, and your home is assessed at $600,000. Your neighbor also owns a five-bedroom, three-car garage home with approximately the same square footage, built in the same year as your home, yet their home is assessed at $480,000. There could be several reasons for this. One is that the other home hasn’t been reassessed for a number of years. Another is that there were errors in the assessment of either or both homes. Such discrepancies can be a reason to ask for a reassessment.
Guide the assessor
You do not have to allow the tax assessor into your home. However, many towns have a policy that if the homeowner does not grant full access to the property, the assessor will automatically assign the highest assessed value possible for that type of property—fair or not.
Many people allow the tax assessor to wander about their homes unguided during the evaluation process. This can be a mistake. The assessor might notice the good points in the home such as the new flooring or lighting fixtures and overlook outdated appliances, lower quality finishings in some rooms, small cracks in the ceiling, etc. If you walk through your home with the assessor you can point out those deficiencies.
You can also talk to the assessor and ask about the criteria they are using in their evaluation.
Check with your taxing authority to see if you qualify for an exemption. Some states and municipalities lower the tax burden for:
- People with certain disabilities
- Agriculture properties
What if you don’t like your reassessment?
You can usually correct minor errors and misunderstandings with the assessor, but beyond that you will need to file a formal appeal with the city’s Board of Assessors. Filing a tax appeal may cost you a small filing fee and generally requires the help of a lawyer, who will also charge a fee, which in some cases is a portion of the savings on your tax bill if your appeal is approved. Keep in mind, though, that the appeal process is not a guarantee that your bill will drop. It may remain the same or, in rare cases, it may increase if the reviewer feels your assessment is too low.
Taxes on Goods and Services
The sales tax is most often used as a method for states and local governments to raise revenue. Sales taxes are considered regressive because they take a larger percentage of income from low-income taxpayers than from high-income taxpayers. To make such taxes less regressive, many states exempt basic necessities such as food from the sales tax.
Retail purchases are assessed as a percentage of the sales price and rates vary between jurisdictions and the type of item bought. For example, a pair of shoes may be taxed at one rate, restaurant food at another, while certain items bought at a grocery store may not be taxed at all.
Some believe that sales taxes are the most equitable form of taxation, since they are essentially voluntary and they extract more money from those who consume more. Others believe that they are the most regressive form of taxation, since poorer people wind up paying a larger portion of their income in sales taxes than wealthier individuals do.
It’s easy to forget about taxes that you don’t pay directly. Such “excise” taxes are based on the quantity of an item and not on its value. For example, the federal government imposes an excise tax of 18.4 cents on every gallon of gas purchased, regardless of the price charged by the seller. States often add an additional excise tax on each gallon of fuel. However, when you buy gas for your car, these taxes are baked into the cost for the gas.
User fees are taxes that are assessed on a wide variety of services, such as airline tickets, rental cars, toll roads, utilities, hotel rooms, licenses, and financial transactions. Some purchases, like cell phone or cable service, may have several user taxes, running up the monthly bill by as much as 20 percent. “Sin” taxes are imposed on items like cigarettes and alcohol. “Luxury” taxes are imposed on expensive or extravagant items, such as expensive cars or jewelry.
Often, states with no sales tax assess higher income or property taxes, so you can’t assume it costs less to live in one state or another based on one tax alone.
There is wide variability from state to state as to the rate of taxes on goods and services, to the extreme of no sales tax at all. Often, states with no sales tax assess higher income or property taxes, so you can’t assume it costs less to live in one state or another based on one tax alone. In addition, the quality of life in a particular state or city is influenced by its ability to invest in infrastructure, education, healthcare, and other important services. Those services are paid for with taxes.
Do you live in Alaska, Florida, Nevada, South Dakota, Texas, Washington, or Wyoming? If so, you are one of the lucky citizens who pays no state income tax. However, these states do differ in other regards:
- The total state and local tax burden on Alaskans, including property, sales, and excise taxes, is just 5.10% of personal income, the lowest of all 50 states. For comparison, New York’s tax burden is 12.97% of income.
- Sales and property taxes in Florida are above the national average, but the overall tax burden is just 6.56%—the third-lowest in the country. But Florida is still not as affordable as most states due to its higher-than-average cost of living, particularly housing costs.
- Although Nevada has no income tax, it relies heavily on revenue from high sales taxes on everything from groceries to clothes, sin taxes on alcohol and gambling, and taxes on casinos and hotels.
- South Dakota has higher-than-average property taxes but lower sales-tax rates than many other states. South Dakotans pay just 7.28% of their personal income in taxes.
- Sales taxes in Texas can be as high as 8.25% and property taxes are also higher than in most states, with the net result being an overall tax burden of 8.18% of personal income.
- Washington residents pay high sales and excise taxes, and gasoline is more expensive in Washington than in most other states. The overall tax burden is 8.20%. Washington also has a higher-than-average cost of living, particularly housing costs.
- Wyoming is the second least densely populated state, and in addition to having no income tax, it has low property and sales tax rates. The overall tax burden as a percentage of personal income is 7.51%.
That wraps up a discussion of taxes (see my posts on income taxes here and here if you missed them). You’ve probably concluded, rightly so, that taxes can be very complicated. There are ways to minimize (legally, of course!) certain taxes. The best ways are to 1) prepare your own income tax return (or at least read through the return if prepared by someone else) so that you understand how to optimize the way you save and spend money, and 2) review your property tax assessment and property tax bill (and ask for a reassessment if yours doesn’t seem accurate). Aside: One of the benefits I realized from reviewing my property tax bill was learning that a portion of the tax collected supported my county library. I LOVE my library and knowing that my property taxes were supporting it made paying those taxes a little less “taxing.”
There’s really not much you can do about sales taxes, except live in a state with low or no sales tax, but then you might just pay more in income or property tax. Or you might not be able to enjoy the communal amenities that taxes afford. Every individual has their own idea of what makes a place a good place to live and low taxes alone do not provide a complete picture of the cost of living or quality of life. Happy filing!