The Dirty Little Secret About Real Estate Taxes and How They Work

The mechanics behind real estate taxes are a mystery to many and I hope to offer some clarification. Real Estate taxes, believe it or not, are not strictly calculated on what your house is worth. I know, it’s crazy. Follow me on this one.

Real estate taxes are somewhat unique in the way they are calculated. We all are used to paying many types of taxes. The two most common taxes are sales tax and income tax. These are fairly easy to calculate because they are just a percentage of what you bought or a percentage of your adjusted gross income. If sales tax is 9%, you know you will pay $9 in tax on your $100 purchase.

Real estate taxes are a different animal. Your real estate taxes go to the county government which then distributes the money to the school districts, townships and etc. While the state government makes its money on sales tax and the federal government makes its money on income tax, the county makes its money on real estate tax.

Every year the local taxing bodies put together budgets for their annual operations and then the County divides up that amount among all the properties. Let’s assume the County needs to raise $6,750,000 this year. If there are 1,000 properties in the County it would be easy to say each property will need to pay $6,750. however, some properties are worth more than others so it wouldn’t be fair to charge each property a flat amount.

This is where property assessments come in. The county needs to figure out what every property is worth to make sure that it pays its fair share of the taxes. The county assessor (or township assessor, depending on which county you live in) will assess your property at 1/3 of market value. Assessments are broken into two parts, value of the land and value of the structure. So if your house is worth $300,000 (which is the value of your land plus your structure) your assessed value would be $100,000. Now that every parcel has an assessed value, the county adds them all together to figure out what all the property in the county is worth.

In Portfolio County, which is a very small, imaginary county, the total assessed value of all the property is $100,000,000. (Keep in mind that the total assessed value is 1/3 of market value, so the total market value of the property is $300,000,000.) After exhaustive board meetings, Portfolio County determines that it needs to raise $6,750,000 in real estate taxes to meet its budgets. Portfolio County then comes up with a multiplier to get the money it needs out of all the real estate. The multiplier is calculated by taking the amount of money needed, $6,750,000, and dividing it by the total assessed value of the real estate in the County, $100,000,000. This leaves us with a multiplier of .0675 or 6.75%.

Now any parcel can have its real estate taxes calculated. A large property with an assessed value of $250,000 will pay $16,875 (6.75%) whereas a home with a $40,000 assessed value will only pay $2,700. Now we get to the heart of the matter. How can my assessed value stay the same or go down while my tax bill goes up?! I’m glad you asked! Let’s look at an example:

In 2006, Joe’s house in Portfolio County had an assessed value of $125,000 and he paid $8,437.50 in real estate taxes. In 2007, Portfolio County had a lot of road work they had to do and needed more money for their budget. Instead of needing the $6,750,000 they did in 2006, they needed $9,000,000 in 2007. So what the county did was increased the multiplier to raise enough tax revenue. The new multiplier for 2007 was now .09 or 9%. So even thought Joe’s 2007 assessed value stayed the same at $125,000, it was multiplied by 9%, resulting in an $11,250 tax bill, a $2,812.50 increase from 2006.

Even assuming Joe challenged his assessed value and was able to get it reduced to $100,000 in 2007, at the 9% multiplier, he still would have paid $9,000 in real estate taxes, an increase from 2006.

The main factor which drives how much you will pay in real estate taxes is HOW MUCH MONEY THE COUNTY NEEDS TO RAISE, not how much your house is worth or its assessed value. If everyone had their assessed value reduced by 50%, their taxes would stay the same since the county still needs the same amount of money. All the county would do is double its multiplier. Long story short, real estate taxes are driven by how much money the county needs to raise, not necessarily your assessed value.

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