Understanding Property Taxes When Buying A Home

Taxes tied to property have existed since ancient times. In early American colonies, tax structures varied from one to the other, and in time, the funds from their robust tax systems helped spur the audacity of challenging one of the world’s greatest military powers in the Revolutionary War. 

Now, most people accept grudgingly that taxes are an unavoidable part of life, and that’s true for homeownership as well. Before buying a home, make sure you understand how property taxes are calculated, paid, and possibly reduced.

Who levies property taxes?

Property taxes are levied at the municipal level, and they are a major source of income for city and county governments. Typically, each city, county, and school district has the power to levy taxes on property within their jurisdiction.

How are property taxes calculated?

Generally, taxes are determined by multiplying the property tax rate (or millage rate) by the current market value and are recalculated anywhere from one to five years by a local tax assessor. The lower the valuation of a property, the lower property taxes will be.

The market value is based on both the land and structures on it, but the method of assessing property can vary from one local government to the next. 

Three ways of assessing property value

1. A Sales Evaluation – This method assesses the property based on what it’s likely to sell for in a transaction. The assessor will compare it to similar properties that recently sold in the area based on location, market conditions, the state of the property, and any improvements.
2. The Cost Method – Another method involves estimating how much it would cost to replace it. This examines the depreciation of a property and the costs of building materials and labor.
3. The Income Method – The last method is based on how much you could make from the property if it was rented. The assessor will take into account expenses like maintenance, managing the property, insurance, and taxes, as well as the profit. 

The role of the assessor is to estimate the property values. They do not collect taxes. While some of the items that determine a land’s tax rate make sense, some of the factors are subjective. Factors like how much income or value a property could potentially generate if developed may affect the assessment. 

For instance, the same piece of vacant land could have wildly different tax bills depending on where it is and who assesses it. If it has water, sewer, and gas hookups, or if an assessor feels that the land has the potential to be developed, it could lead to higher taxes too. 

After assessing the market value, the taxable amount is determined by applying a uniform percentage, which varies by taxing jurisdiction and could be any percentage below 100%. If you believe your property is overassessed, many counties provide a process for homeowners to contest it. 

What do property taxes pay for?

Municipal budget hearings are held to determine how much tax money needs to be collected to support local services, which include:

• Education 
• Libraries
• Infrastructure
• Law Enforcement
• Fire Rescue
• Parks and Recreation
• Public Transportation
• Water and Sewer Improvements
• Other services that benefit the community

Homeowner Tax Exemptions and Deductions

A tax exemption reduces your overall taxable income or in the case of your house, reduces the taxable amount for property taxes.

A tax deduction, on the other hand, is divided into two main types:

• Standard Deductions
• Itemized Deductions

Deductions are the result of the expenses you’ve incurred over the year. You can opt to only use one type when you file your taxes.

Both exemptions and deductions are like an adjustment to your income or taxable assets. For homeowners, this means that certain items or labor used to improve your home may qualify for deductions. If you choose this route though, you will have to figure out if itemizing your deductions will save you more money than taking the standard deduction.

Tax credits are another way to save money during tax season. Credits are similar to deductions in that they can be applied if you’ve spent money on but they are subtracted from your taxes directly. An example of this type of credit is the Residential Renewable Energy Tax Credit.

To see what other tax credits are available in your state, county, or city for making energy-efficient improvements, visit the US Department of Renewable Energy’s website.

What is a homestead exemption?

A homestead tax exemption is applied to your primary residence and reduces a homeowner’s property tax obligation by a certain amount in dollars or a percentage of the home value. This exemption can’t be applied to investment or rental properties.

In Texas, if a home is bought mid-year, you enjoy the homestead exemption from the previous owner and then you can homestead it for the following year. If it’s a new build or bought from an investor that didn’t homestead the property, you will lose out on that exemption until January 1st, 2020. 

Tax Certificates are most common in Texas because of how the state assesses each homeowner’s property taxes. 

Other Types of Property Tax Exemptions 

• Disabled Veteran Exemption
• Senior Citizen and Disabled Citizen Exemption
• Widow/Widower Exemption
• First Responders Exemption 
• Surviving Spouse of First Responders Exemption 
• Improvement Exemption – Allows you to renovate without paying taxes on the improved assessed value

Each state and county may offer an exemption with different caveats, so it’s important to ask your local assessor for more information. Applying for an exemption could help you save several hundred dollars each year on taxes. 

Clearing Tax Issues Before Buying a Home

Homebuyers will want to make sure that the property they purchase is free and clear of all liens, including tax liens. Lenders who finance your deal will also want to know if there are liens that will take priority over the mortgage, so a title report and a title insurance policy are required. 

The title company or real estate law firm in charge of a closing will be the one to complete a check on the property to see if any outstanding liens need to be released or cleared from the public record before the transaction. 

Property Reports that help find tax information

An official title search will find recorded liens against a property, but there is additional information that buyers need to know regarding taxes. PropLogix provides two reports that offer title agents, investors, and buyers with some tax information. 

1. Tax Certificates – This is sometimes called a Tax Report. This report is important to understand if any current exemptions are applied to a property that a new homeowner may not be qualified for. These reports are common in Texas.
2. Municipal Lien Search – This report looks for any pending issues on a property that has yet to become an official lien in the public record. Title agents use these searches to supplement their title searches. The report includes the three most current real estate property tax years as well as any unpaid prior years and/or tax lien certificates (not the same thing as a Tax Certificate) issued by the municipality.
3. Land Surveys – Land surveys determine if your property consists of more than one lot or parcel based on the legal description. Without that knowledge, unsuspecting homebuyers could get PIN slammed. This is when a second Property Index Number (PIN) isn’t disclosed to the buyer before closing, and they end up getting “slammed” with a doubled tax bill.

With these reports, homebuyers can have a clearer picture of how much they’ll be paying in taxes after closing. 

How are property taxes paid? 

After closing on a house, the process of paying taxes can depend on what type of mortgage you have and your lender’s requirements. 

Paying Taxes with Escrow

An escrow account is set up at closing with a financed loan and managed by your mortgage or loan servicing company. The servicer will deposit a portion of each monthly payment into your escrow account to pay for the expected property taxes and home insurance and flood insurance premiums. However, it won’t pay for homeowner’s association fees, monthly utility bills, or special assessments. 

An escrow account is required for government-backed loans like FHA and USDA loans, but even lenders offering conventional loans may require this of borrowers. That’s because local and state real estate tax liens take priority over other liens on your property. In order to preserve their first-lien priority, lenders want to control tax payments. 

Escrow accounts benefit borrowers by: 

• Spreading payments out over the year instead of paying a lump sum at once 
• Making it easier to budget monthly expenses 
• Reducing how many parties you pay 

If you don’t have an escrow account, you’ll be responsible for sending out those checks to your tax collector and insurance companies.

Reducing Your Property Taxes by Protesting Its Assessed Value

In addition to filing for the appropriate tax exemptions as a new homeowner, homeowners can also protest the assessed value of their property as a way to reduce their tax burdens. In most states, there are annual increase limits. These caps can vary from as low as 2% in California to as high as 10% in Texas.

If you’re not happy with the assessed value determined by your County Appraisal District or County Tax Assessor, you can potentially reduce the amount by requesting a comparative market analysis from your Real Estate Agent or a Professional Real Estate Appraiser.

However, if the information comes back showing your house’s market value is lower than you expected, it’s best not to pursue a protest.

If the analysis shows that your property is evaluated too high, you can take this information to your County Appraiser’s Office and request that the assessed value be lowered to reflect the true market value. 

Another method includes finding another house in your subdivision with a similar floor plan and checking its assessed value on the property appraiser’s website. If the evaluation is lower, document this as part of your protest. You can print or save this public information like photos of each property, drawings of floor plans, and tax records you find on the appraiser’s website. 

Additionally, if your property has sustained damage from a natural disaster, get estimates to demonstrate that your home’s value should be lower.  

Once you have all this information documented, you can usually file the protest online or write or call your County Appraisal District to learn how to file a protest. Do it as soon as possible since many have deadlines for filing a protest.

Key Tax Takeaways for Homebuyers

Owning a home comes with a lot of responsibilities and additional costs that might not be obvious at first. While no one enjoys paying taxes, simply refusing to pay them will result in hefty fees and even potentially losing your home. Before purchasing a home, make sure you do the following:

• Avoid unexpected property taxes by reviewing documentation, like land surveys, tax reports, and deeds, provided by real estate professionals. If you have questions, reach out to your real estate agent or attorney for clarification.
• Understand what exemptions may apply to you and your property, like Homestead, Disabled Veteran, and/or Over 65 Exemption. Be sure to fill out the correct forms to ensure the exemption is applied.
• Depending on the timing of the sale, you may have to pay a higher or lower tax amount until your exemptions are applied.
• Most Exemptions do not transfer during a sale. For instance, if a young civilian family purchases a home from a seller with a Disabled Veteran and/or Over 65 Exemption, the new owners would not qualify for those exemptions.
• Understand how your taxes will be paid 
• Reduce your tax burden further by protesting your property’s assessed value.