1 August 2011 How Property Taxes Work The property tax is the oldest major revenue source for state and local governments. At the beginning of the twentieth century, property taxes represented more than eighty percent of state and local tax revenue. W hile this share has diminished over time as states have introduced sales and income taxes, the property tax remains an important mechanism for funding education and other local services. This policy brief discusses why property is taxed and how property taxes are calculated. Why Tax Property? stocks and bonds. Most states have moved away from taxing personal The property tax is rooted largely in the “benefits principle” of taxation. property and now impose taxes primarily on real property. Under this view, the property tax essentially functions as a user-charge on local residents for the benefits they receive from the local policies funded by property taxes. These policies benefit local residents directly How Property Taxes Work in the form of better schools and fire protection, and indirectly in the Market Value form of increased housing values. X The property tax also helps differentiate between families of very Assessment Ratio (between 0 & 100%) different means by taxing families with large quantities of wealth more = heavily than those without such reserves. But the impact that property Assessed Value taxes can have on low-income families, and particularly the elderly, - makes clear that the linkage of the property tax to the ability-to-pay Exemptions principle is far from perfect. = Taxable Value Finally, the stability and enforceability of the property tax make it X among the best options available for providing local governments with Sum of All Relevant Millage (Tax) Rates a predictable revenue stream that can be used to fund indispensable services like schools, roads, and public safety. = Property Tax Before Credits How Property Taxes Work - Homestead Credits & Circuit Breakers Historically, property taxes applied to two kinds of property: real property, which includes land and buildings, and personal property, = which includes moveable items such as cars, boats, and the value of Property Tax Owed www.itepnet.org • [email protected] • 202-299-1066 Tel: Fax: Washington, DC 20036 • 1616 P Street, NW Suite 200 202-299-1065 •

2 In its simplest form, the real property tax is calculated by multiplying rate is usually the sum of several tax rates applied by several different the value of land and buildings by the tax rate. Property tax rates are jurisdictions: for example, one property might be subject to a municipal tax, a county tax, and a school district tax. This calculation yields the normally expressed in mills. A mill is one-tenth of one percent. In property tax before credits. tentative the most basic system, an owner of a property worth $100,000 that is subject to a 25 mill (that is, 2.5 percent) tax rate would pay $2,500 Many states allow in property taxes. In reality, however, property taxes are often more property tax credits that either directly reduce the property tax bill, or that reimburse part of the property tax bill separately complicated than this. The first step in the property tax process is for tax purposes. In most cases, this determining a property’s value when taxpayers apply for them. Subtracting these credits is the final —though taxpayers are often means estimating the property’s market value, the amount the property property tax bill step in calculating one’s would likely sell for. required to pay the pre-credit property tax amount, only to later have the amount of the credit refunded to them. (For more detail on one type of property tax credit, see ITEP brief, property’s assessed value , its value The second step is determining the “Property Tax Circuit for tax purposes. This is done by multiplying the property’s market ). Breakers” assessment ratio value by an , which is a percentage ranging from Other Property Tax Issues zero to one hundred. Many states base their taxes upon actual market W hile property taxes on owner-occupied homes tend to receive the value—in other words, these states use a 100 percent assessment most attention, the presence (or absence) of tax on other forms of ratio. A significant number of states, however, assess property at only a property also has important implications. fraction of its actual value. New Mexico assesses homes at 33.3 percent of their market value, and Arkansas uses a 20 percent assessment ratio. • Businesses pay property taxes just like local residents. Property Some states place a cap on increases in a home’s assessed value in any given year, which in many cases can lead to vastly different assessment taxes on businesses are mostly borne by business owners. Business property taxes generally make the property tax less regressive, since ratios among similarly valued homes (For more detail, see ITEP Brief, “Capping Assessed Valuation Growth: A Primer” business owners tend to be wealthier than average. ). And even when the law says properties should be assessed at 100 percent of their value, local assessors at times systematically under-assess property, reporting • Property taxes also impact taxpayers who rent, rather than own their assessed values that are substantially less than the real market value of home. This is because owners of rental real estate pass through some of their tax liability to renters in the form of higher rents. The impact the property. of property taxes on renters is of particular concern because renters tend to be significantly less well-off than their homeowner neighbors. After the assessment ratio has been factored in, many states reduce a . The most exemptions property’s assessed value further by allowing • Non-profit entities are generally exempt from state and local common type of exemption is referred to as a “homestead exemption.” In Ohio, for example, the state allows an exemption for the first $25,000 property taxes. W hile these exemptions can make it easier for of home value. Subtracting all exemptions yields the taxable value these organizations to pursue their missions, it can mean that local of a property. (For more on homestead exemptions, see ITEP Brief, governments have difficulty raising the revenue needed to provide quality public services. This issue is most significant in areas with “Property Tax Homestead Exemptions” ). large non-profit hospitals and/or universities. The next step in the process is applying a property tax rate, also millage known as a millage rate, to the property’s taxable value. The • [email protected] www.itepnet.org • Fax: Tel: • Washington, DC 20036 • 1616 P Street, NW Suite 200 202-299-1065 202-299-1066

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