Educating Your Clients on Property Taxes

September 6, 2022
10:00 am

Paying property taxes is an unavoidable part of homeownership. But why are you charged these taxes and what determines how much you pay? Here’s a brief primer on property taxes to better educate your clients.

Where does all that money go?

Property taxes are sources of revenue that state and local governments use to pay for necessities we often take for granted. Property taxes are the primary source of funds for roads, public schools, public safety (police, fire and ambulance services), community hospitals, and public colleges in many states.

Property taxes are not the only source of tax revenue for state and local governments. 

  • Many states also have sales taxes.
  • State and local governments charge fees for such items as driver’s licenses, auto registration and occupational licenses.
  • Fees for public utilities such as water, sewer systems, and trash collection are another source of governmental revenue. 
  • Some states have a state income tax. States that do not have income taxes rely more heavily on property and sales taxes.
  • States with big tourism industries often charge taxes on entertainment, hotels and motels. Visitors to the state generally pay these taxes. 
Breaking down the bill

Two components go into calculating your property tax bill. 

First, elected officials set state and local tax rates. The state legislature and governor typically determine rates for school funding. County commissioners and the city council set local tax rates. Your overall tax rate is a composite of several separate rates for such items as schools, county and city government operations and local community college and utility districts.

The second component is your property’s valuation. Taxes based on the property’s value are called ad valorem taxes. Each year, a county appraiser visits your property and estimates your square footage from your home’s exterior dimensions and the number of stories. The appraiser then compares market sales data on similar homes to determine your property’s assessed value.

Your total tax bill is determined by multiplying the second component by the first. 

Many states allow a homeowner to exempt some of her property’s valuation from taxation or freeze the valuation for some property taxes. For example, in some states you might exempt $25,000 from taxation as a “homestead exemption,” and your home’s valuation may freeze with regard to school taxes when you reach age 65. 

Yikes! Is it always that high?

The property tax rate and home valuations vary from state to state. They are often a function of the size of the relevant cities, infrastructure and school systems, as well as whether the state depends mostly on property taxes or also gets revenue from state income taxes or sales taxes.

High-tax states like Illinois and Texas have property taxes well over two percent of valuation. On the other end of the spectrum, states like Alabama have taxes of less than one-half percent. 

How are property taxes paid?

County governments make property valuations early in the year and send value notifications by June. A separate office called the tax assessor sends the tax bill a few months afterward. Some states allow for two payments with deadlines for each. The entire bill usually must be paid by December 31. 

If you have a mortgage, your monthly payment includes funds designated to pay your tax bill. Your lender holds these funds in escrow and pays the assessor when the tax bill is due. (Make sure the mortgage lender pays the bill on time and within the current tax year so that you are eligible for the federal tax deduction discussed below.) Your mortgage company may require you to keep a reserve of two or three extra months’ taxes in escrow if your tax bill is higher than expected.

If you don’t have a mortgage, you pay property taxes directly to the assessor.

The federal income tax deduction

Fortunately, you can deduct the state property taxes you pay, subject to certain limits, from your income for federal income tax purposes. If you are eligible to itemize your deductions — that is, if your total itemizable expenses such as charitable giving and medical expenses above a certain threshold are larger than the standard deduction — then you can deduct up to a total of $10,000 in property, sales and state income taxes you paid during the taxable year.