How Does Real Estate Tax Work?

Real estate tax rates and property values are different from state to state, but every homeowner can get confused or frustrated about the policies. Industry lingo and terms can be hard to unpack, and beyond that, you might have practical questions, like why your family member in a different state pays less taxes for a nicer house.

The typical US homeowner pays just over $2,300 in property taxes each year, per property. But some people might pay only a quarter of that, while others pay double. It isn’t just the value of the property in question that affects the property tax bill, but also the state tax rate, how you use the home, and even when and how you sell it. Let’s take a deep dive into just how real estate taxes work and try to clear the air around this expense.

Real Estate Taxes vs Property Taxes

The terms “real estate tax” and “property tax” are often used interchangeably, which can be confusing. The good news is these terms represent the same concept in discussions about land and residential property. Whether you call it “real estate tax” or “real property tax” these are taxes paid annually to state and local governments. They fund infrastructure and community services like road repair, municipal parks, fire and police, schools, and more.  

What gets confusing is that real estate tax is just one kind of property tax. Real estate is considered immovable property, which probably seems obvious, but under the law it’s a valuable distinction. You may also pay what’s called “personal property tax” on movable assets like cars, trucks, mobile homes, boats, planes, and so on. You pay these taxes at the time the vehicle or asset is registered and when registration is renewed.  

What are the 3 Types of Real Estate Taxes?

The three types of real estate taxes are real property tax, stamp tax, and capital gains tax.

• Real Property Tax: Your annual rate of residential property tax is based on the assessed value of your home and land. Your home will be regularly reassessed and your tax bill might go up or down as a result. The average residential property tax in the US is 1.1%, though some states are well below one percent, and others more than 2%. 
• Stamp Tax: Also known as “stamp duty,” this is a tax on legal documents that dates back to the Revolutionary War era. This is a one-time tax paid during closing on the home, and costs are usually around 1% of the amount of the sale. As part of the closing costs, who will pay this tax is often part of the sale negotiations. 
• Capital Gains Tax on Real Estate: If you sell a home or land for more than the purchase price, the difference will be taxed as income. This is called capital gains tax. The rate of the tax is progressive based on the other income you declare on your annual income taxes, as well as your filing status. It could be as little as 0%, or as high as 20%. Working with a tax professional is a great idea to offset a potential big tax bill if you sold your property for a great return. For instance, did you know you might be able to deduct expenses for the time and money you put into selling the property?

Common Property Tax Questions

Beyond the types of property tax that affect the closing on and ownership of a home, people often have questions about how these taxes work, and how long they are paid. Let’s run through more common property tax questions:

• How do Property Taxes Work When You Buy a House? Your mortgage lender takes responsibility for making sure the real estate taxes on your home are paid. When you purchase a home, your first year’s worth of property taxes are included in closing costs as part of the initial short-term escrow account. For later years, part of all your monthly mortgage payments go into a long-term, second escrow account that your lender will use to pay the future taxes (along with other expenses like insurance.) Changes in your property tax can be one of the drivers that causes your mortgage payment to go up or down a little each year.
  
  If you buy a home without a loan, you will be responsible for making sure property taxes are paid, usually semi-annually on March 1 and September 1. Taxes are paid in advance, so the amount you pay in March will cover your taxes until August, and so on. This is why it’s important not to miss a payment, because a lien could be placed on the property. 
  
  
• Do You Still Pay Property Tax After a House is Paid Off? Yes, you still pay property tax after your house is paid off. The only difference is that your lender will no longer take responsibility for ensuring these payments are made. You will need to determine the appropriate local government office to send these checks to, or maybe pay electronically. Make sure to get a receipt or documentation!
  
  
• Where Can I Find Property Taxes By Address? If you want to look at the property tax history of a residence you are considering buying, or your current property, the good news is these are public records. Look up your county and state, along with property tax, and you will probably be able to access an online portal to view this information. Short of that, you should be able to call and request the information or visit an office in person to get these records.

• Which States Do Not Have Property Tax? There is no state that does not charge some form of real property tax on real estate. There are 23 states that do not tax personal property like vehicles, but you will be charged real estate tax in any state you choose to call home. 

Taxes on Primary Residence vs Second Home vs Investment Property

The IRS defines a “second home” as one that you live in 14 days per year, or 10% of the days you rent it out, whichever is greater. This means if you rent the home out for 300 days a year, you need to live in it yourself for 30 additional days. These days do not have to be consecutive. There is no limit on the number of “second homes” you can have, as long as you make sure you have met the residential requirement for each one.

The benefit of having a property as your primary or secondary residence is that you can qualify to itemize the mortgage interest tax deduction, up to a total of $750,000 across all properties. If a property is fully a rental or investment property, you cannot deduct the interest paid on the mortgage.

However, an investment property can qualify for what is known as a depreciation, because the IRS recognizes the property does have a finite life span of usefulness. This means you can spread out the total cost you paid for the residence as an annual deduction for 27.5 years for residential property, or 39 for commercial. So, if you bought a $300,000 investment home, you could claim a $10,909 tax deduction every year for 27.5 years. But, if you plan to sell the property, these claims can also become part of your taxable income. Long story short: if you own multiple second homes and investment properties, talk with a tax professional about which strategy will bring you the most lifetime tax benefit from each property.

Call on Delta Wealth Advisors’ Property Tax Strategy Experts

Property taxes are simple on the surface, but when you get into circumstances like owning more than one home, or selling a home for a big gain, things get more complicated. Delta Wealth Advisors offers the full suite of financial services you need to navigate these rules, from bookkeeping and accounting to tax preparation, consulting, and investment management. Don’t let real estate taxes become a real headache. Contact us today for support.