Demand, cost, location, and potential return on investment are among the top concerns real estate investors have when considering a property. Property taxes typically don’t crack the top 10, but they’re just as important.
Property taxes can add up for property owners and add to the overhead cost of owning a rental property.
What are Property Taxes?
Property taxes are taxes paid on property owned by an individual or legal entity. Property tax is an ad valorem tax, which is based on the assessed value of the property, not the initial sale price. Property taxes are calculated by local governments, and most homeowners typically pay their tax bills through an escrow account.
In most municipalities, property taxes fund public services like schools, fire departments, water, sewers, and roads.
How are Property Taxes Calculated?
Property taxes are calculated based on the property’s assessed value. The local government typically sends a property appraiser or assessor to assess the property’s market value regularly. In some areas, this may be done every year, every three years, or more. It depends on the location of the property.
Once the appraisal is complete, the local government will apply their property tax rate to the value of the home that’s taxable, minus any property tax exemptions. Property tax exemptions are typically given to seniors, disabled veterans, and nonprofit organizations. Income properties do not qualify.
Here’s an example:
Your rental property was appraised at $250,000, and the local government taxes 50% of the value. Since income properties don’t qualify for property tax exemptions, you pay taxes on $125,000 rather than $250,000.
Property Taxes vs. Real Estate Taxes
According to Investopedia, most people will use the property tax and real estate tax interchangeably. While it’s not wrong, it’s not correct either. Here’s why. Real estate taxes are a type of property tax, but not all property taxes are real estate taxes. Here’s how. Real estate taxes are only applied to real property. Property taxes can include real property and other personal property like a car or boat.
What States have the Best Property Taxes?
Every year, the Tax Foundation ranks states based on their property taxes. The Tax Foundation evaluates all elements of property taxes in each state, not just real estate taxes. They consider state and local taxes for real and personal property, net worth, and asset transfers.
Property taxes are just one element to consider when purchasing a rental property. Homebuyers and real estate investors should also consider a state’s income and sales taxes because they impact the overall tax burden. Use this table and information below as a guide to help you.
The 5 States with the Lowest Property Tax Rates
Here are the five states with the lowest property tax rates, according to The Tax Foundation.
Indiana
Indiana is the state with the lowest property tax rates. The state’s average effective property tax rate is 0.81%, and, according to SmartAsset, the median annual property tax paid in Indiana is just $1,263.
Indiana also has a 3.23% individual income tax rate and a 7% sales tax rate, which is why it ranks 11th for lowest cost of living.
Indiana is truly an affordable real estate market for real estate investors and their prospective renters.
New Mexico
The average effective property tax rate in New Mexico is 0.78%, and the median annual property tax paid is $1,403, according to SmartAsset. New Mexico also has a graduated income tax ranging from 1.7 – 5.9% and a 5% sales tax rate. That’s why New Mexico ranks in the top 20 for the cost of living.
Idaho
Idaho may not be in the top 20 when it comes to living, but it ranks 3rd for property taxes. According to SmartAsset, the median annual property tax is $1,616.
Like New Mexico, Idaho has a graduated income tax ranging from 1 – 6.5%. Idaho’s sales tax is 6%.
Delaware
Like Idaho, Delaware has a higher cost of living but low property taxes. SmartAsset states the average effective property tax rate in Delaware is 0.56%, and the median annual property tax rate is $1,710 when applied to the state’s median home value of $300.000.
Like New Mexico and Idaho, Delaware’s income tax is graduated. It ranges from 2.2 – 6.6%, depending on household income. Unlike the other states in the top 5 for lowest property taxes, Delaware does not have a state sales tax.
Nevada
Nevada is another state with a high cost of living but low property taxes. According to SmartAsset, Nevada’s average effective property tax rate is 0.53%, and the median annual property tax rate is $2,200 when applied to the state’s median home value of $400,000.
Nevada is the only state in the top 5 for lowest property taxes that do not have an income tax. However, it has a combined local sales tax rate of 8.23%.
The 5 States with the Highest Property Tax Rates
And here are the five states with the highest property tax rates, according to The Tax Foundation.
Massachusetts
Massachusetts ranks 45th regarding property taxes and 47th for cost of living. Massachusetts’s average effective tax rate is 1.17%, and the median annual property tax payment is $4,899, according to SmartAsset.
Massachusetts also has a 5% income tax rate for earned and unearned (interest, dividends, capital gains) income.
New Hampshire
New Hampshire ranks 46th for property taxes with an average effective tax rate of 2.05%. The median annual property tax payment in New Hampshire is $5,768, according to SmartAsset.
New Hampshire is one of two states (Alaska is the other) that doesn’t have an income or sales tax. That’s why it has some of the highest property taxes in the country. It’s where the government generates the revenue it needs to provide public services for residents.
New York
It’s no surprise that New York State clocks in at 47th for property taxes and 49 for the cost of living. It has a reputation for being one of the most expensive states. SmartAsset states the average effective property tax rate in New York State is 1.69%. Surprisingly, it’s just 0.88% in New York City.
New York requires anyone, resident or not, who makes income in New York to pay state income taxes ranging from 4 – 8.82%. The sales tax rate in New York is 4%.
Vermont
Vermont ranks 49th for property taxes with an average effective tax rate of 1.86%. SmartAsset lists $4,340 as the average annual property tax in Vermont.
Vermont is another state with a graduate individual income tax. It ranges from 3.35 – 8.75%. The state also has a 6% sales tax. When you combine property taxes, income tax, and sales tax, it’s not hard to see why Vermont is one of the most expensive states for property owners.
Connecticut
And the most expensive state for property taxes is… Connecticut! Connecticut’s average effective property tax rate is a whopping 2.14%, according to SmartAsset.
Connecticut has an individual income tax rate of 4% and a state sales tax of 6.35%. No wonder it’s the most expensive state.
Bonus: District of Columbia
The District of Columbia (D.C.) isn’t technically a state, but it’s worth mentioning. It ranks at the bottom for property taxes and the second to last for the cost of living. SmartAsset states the average effective property tax rate is 0.56% in Washington D.C., and the median annual real estate property tax payment is $3,647.
Washington D.C. also has a graduating income tax rate of 4 – 10.75% and a fixed sales tax rate of 6%.
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