Real estate taxes are a given when owning real estate. And savvy real estate investors use them to determine whether or not a property makes a good investment. This includes everything from their purchasing budget to revenue projections.
Ad valorem tax, or property tax, is the most expensive tax real estate owners pay. Here’s a closer look at ad valorem tax and how it’s assessed. Use it as a guide when determining whether or not a potential property will make a good investment.
Key takeaways:
- Ad valorem tax is based on the assessed value of real or personal property.
- Ad valorem tax is very different from sales tax or income tax.
- Local municipalities and jurisdictions typically levied ad valorem, or property taxes. They’re calculated annually and paid through an escrow account.
What is ad valorem tax?
Ad valorem is Latin for “according to value.” So, unlike excise or transactional taxes, where the tax amount or percentage is constant, ad valorem tax is proportional to the property’s assessed value.
Cornell Law School clarifies that “ad valorem tax is commonly used in the taxation of real property.” Real property is generally fixed property, that is, land or buildings. That’s why they’re often referred to as property taxes.
How ad valorem tax is assessed
Ad valorem, or property taxes, are levied based on the value of the property being taxed.
In most municipalities and jurisdictions, a public tax assessor is sent to the property to determine its fair market value. Fair market value is the estimated sales price of a property. Tax assessors use the property’s valuation to calculate its property taxes. The tax rate is a fixed percentage of the assessed value. The ad valorem tax is then annually levied on the property.
Tax assessments for ad valorem taxes are usually calculated by January 1 every year because it is an annual tax.
How ad valorem tax is levied
Ad valorem, or property taxes, are typically levied by a local municipality or jurisdiction. However, they can also be levied by other local government entities. This includes county governments, school districts, and other special-purpose districts.
Depending on where the property is, real estate investors may have to pay ad valorem taxes to more than one entity. For example, it’s not uncommon for the municipality (city) and county to levy ad valorem taxes on real estate. The reason? Ad valorem taxes are a major source of revenue for local and state governments.
The 5 types of real estate subject to ad valorem tax
As mentioned above, ad valorem property taxes may be levied on personal or real property. Personal property, like a motor vehicle or boat, may be subject to property taxes. For our audience, we’re focusing on real property, specifically real estate.
Real estate is a form of real property and, therefore, subject to ad valorem taxes. There are five categories of real estate, and all are subject to property taxes.
Residential
Residential real estate is any property used for residential purposes. This includes single-family homes, condos, townhouses, and individual units of multifamily residences.
Commercial
Commercial real estate is any property used for business purposes. This includes apartment complexes, gas stations, stores, hotels, office buildings, shopping centers, etcetera.
Industrial
Industrial real estate is any property used for the manufacturing, production, distribution, storage, research, and development of goods.
Land
Land includes any undeveloped property (vacant land) as well as farms, orchards, ranches, and timberland.
Special use
Special use property is any property used by the public. This includes government buildings, parks, churches, schools, and cemeteries.
The category of the real property being assessed determines its ad valorem property tax percentage.
How to calculate ad valorem tax
Estimating ad valorem tax is a good idea before purchasing an investment property. Fortunately, it’s simple. Here’s the formula:
Ad valorem tax = Assessed value x Tax rate
A tax assessor determines the assessed value. However, you can use the list price to get started.
The location of the property determines the tax rate. You can get this information from the local tax commissioner’s office.
Let’s look at an example.
Let’s say you’re looking to purchase a single-family home in Tampa, Florida, to use as an investment property. The home is listed for $499,000 and is located in Hillsborough County. Hillsborough County has a 1.09% county tax based on the property’s current value.
$5,4339.10 = $499,000 x .0109
The estimated county ad valorem, or property taxes, on this single-family home are $5,4339.10 per year. That’s $453.26 per month.
However, this estimate is low because properties in Tampa are also subject to a school levy, a city levy, and four special district levies.
To simplify these taxes, Tampa levies property taxes based on millage. A millage rate is different than a fixed percentage. A mill is 1/1000 of a dollar. With millage, property taxes are computed by multiplying the property’s taxable value by the number of mills levied.
In Tampa, the millage is 19.71, which equates to $19.71 for every $1,000 of the property’s taxable value. This equates to an estimated annual property tax of $9,835.29. That’s $819 per month.
The State of Florida offers a homestead exemption on properties used as the owner’s primary residence. This exemption reduces the property’s assessed value and decreases the property taxes. Since this property will be used as an investment property, you will be subject to the higher tax rate.
We chose this example for two reasons. One, it shows how easy it is to estimate the amount of tax you may pay. Second, it demonstrates the importance of understanding how tax districts and tax exemptions work at the local level. You can easily get this information from the local taxing authority.
What are ad valorem taxes used for?
Ad valorem, or property taxes, are used to fund many public services. This includes local schools, law enforcement, fire protection, libraries, infrastructure, road maintenance, parks services, and many other community projects.
How to pay ad valorem tax
Most taxpayers pay ad valorem tax payments as part of their monthly mortgage payments. The reason? Mortgage services often collect tax payments in monthly installments, put them in an escrow account, and then pay them for you annually.
However, if the mortgage lender allows, property owners and investors can choose to make annual or semi-annual payments directly to their local tax collector’s office.
Closing thoughts
Property taxes are an expense anyone who owns real property must contend with. If you’re looking to invest in a property, use this knowledge to your advantage. It’ll help you estimate how much house you can afford as well as your monthly mortgage payments. This, in turn, helps you determine how much rent you’d have to charge to make a profit and assess whether or not it’s competitive for the area.
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