Taking Advantage of Property Tax Abatement Programs

Property taxes represent a major expense for most homeowners, typically amounting to 1% to 3% of the home's value each year. This recurring expense doesn't go away when you pay off the mortgage. It's a perpetual cost of home ownership.

Some cities offer what's known as property tax abatement or real estate tax abatement. These programs can bring consumers significant savings, allow them to buy more home for the same price, or improve their chances of qualifying for a mortgage by putting a home's total monthly payment within reach.

As an added bonus, property tax abatement can improve a home's resale value for as long as the abatement is in effect. In this article, we'll take a closer look at property tax abatement programs, how you can find one when you're home shopping and whether they have any drawbacks.

What Is a Property Tax Abatement?

Some cities have property tax abatement programs that eliminate or significantly reduce property tax payments on a home for years or even decades. The purpose of these programs is to attract buyers to locations with lower demand, such as city neighborhoods that are in the midst of revitalization efforts. Some cities offer tax abatements citywide, while others only offer them in designated areas. Some cities limit these programs to low-to-middle-income property owners, but many programs have no income restrictions.

You can buy a property that already has an abatement, or you can purchase an eligible property, make the required improvements, and apply for the abatement yourself. The first option is considerably easier because it means someone else has endured the headaches of construction and bureaucracy and all you have to do is move in.

Here are just some examples of actual property tax abatement programs in the United States.

City of Cleveland

Newly constructed single-family homes receive a tax abatement of 100% of the increase in real estate property tax for 15 years. In other words, owners only pay property tax on what the land was worth before it was improved with the new construction. Residential projects must meet Cleveland Green Building Standards.

City of St. Louis

New construction on vacant land or a gut rehabilitation of an existing building is eligible for a property tax abatement lasting five to 10 years. During this period, the property tax rate is frozen at the value of the property before the improvements.

City of Portland, Ore.

Single-family, owner-occupied homes in selected neighborhoods designated as Homebuyer Opportunity Areas are eligible for a 10-year property tax abatement on the value of improvements from rehabilitation or new construction. Property owners only pay tax on the value of the property before the rehabilitation or new construction. The property's sale price must be $405,000 or less for 2020. This amount is adjusted annually. 

City of Philadelphia

New construction and rehabilitated housing have been eligible for a 10-year, 100% tax abatement on the value of improvements. Property owners only paid tax on the value of the property before the rehabilitation or new construction. Starting on Dec. 31, 2020, that abatement will start at 100%, but then be reduced by 10 percentage points a year over the 10-year period.

City of Des Moines, Iowa

Property tax abatement percentages vary depending on the type of improvement and property location. New additions and renovations under $23,000 anywhere in the city are eligible for a 10-year, 115% abatement. (Over $23,000, the abatement is 100%.) New construction and rehabilitation projects are eligible for abatement for six years anywhere in the city on a declining schedule; properties in other specified locations are eligible for a 10-year abatement on a declining schedule.

California (statewide)

The Mills Act provides tax incentives for the restoration and preservation of qualified historic residences. Local governments negotiate these property tax abatements on a case-by-case basis with owners of qualified historic properties. Owners may achieve property tax savings of 40% to 60% per year. The Mills Act program is considerably more complex than the other tax abatement programs listed here.

How Tax Abatement Programs Work

Tax abatement programs reduce or eliminate the amount of property tax owners pay on new construction, rehabilitation, and/or major improvements. They won't completely eliminate your property tax bill—you'll still have to pay taxes on the value of the property before it was improved. But the savings can be substantial. For example, the Portland Housing Bureau says its tax abatement program could save property owners about $175 a month—or about $2,100 a year—for a total savings of $21,000 over 10 years. Without abatement, they might spend about $3,100 a year in property taxes; with it, they might spend about $1,000 a year.

Properties often must remain owner-occupied to continue qualifying for the tax abatement. If the property is sold from one owner-occupant to another, the tax abatement will remain with the home. The abatement period does not start over when the property changes hands, however. If the seller has received seven years of abated property taxes, the new buyer would receive the remaining three years of a 10-year abatement.

The easiest way to find out if there are any property tax abatement programs in the area where you want to buy is to do an Internet search for "property tax abatement" and the name of your city. For large cities, a neighborhood name might be a more effective search term than a city name. The name of your city or neighborhood plus "real estate listings" plus "property tax abatement" is another effective search string. Knowledgeable real estate agents will be aware of these programs.

Potential Drawbacks of Buying a Tax-Abated Property

Tax abatement lowers your property taxes, so how could saving money while getting to live in a new or recently rehabbed property possibly have any drawbacks? Well, there are a few things that could go wrong.

A significant issue is that tax-abated properties are sometimes in less desirable neighborhoods. The tax abatement is an incentive to encourage people to redevelop and move into these areas. Whether revitalization efforts will ultimately prove successful is a big question mark. If the neighborhood doesn't improve, your property value could remain flat or even decline, which could make it difficult for you to sell and possibly cause you to lose money.

If you continue to live in the home past the end of the abatement period, you'll experience a significant jump in your annual housing expenses. It's imperative that you keep an eye on this deadline and plan for the increase, so you'll be able to afford it when the time comes. If you sell the property after the abatement period ends, you may have to lower your asking price to account for the increase in taxes.

Also, tax abatement doesn't give you complete certainty over what you'll spend on property taxes. Even during the abatement period, your tax bill could change. Since you're still paying tax on a portion of your property's value, a change in the tax rate or a special assessment could cause your property tax bill to increase. Since you're being taxed on a lower dollar amount and property taxes are based on a percentage of that amount, any increase probably won't hit your budget too hard, but you should be aware of the possibility of an increase. Changes in tax rates or property values could also cause your bill to decrease, of course.

Finally, the city may reserve the right to end your tax abatement if you become delinquent on your property tax payments. If you're responsible for the payments, don't miss any. If your mortgage company pays your taxes, watch your monthly statements carefully to make sure your tax bills get paid.

Abatement Programs and Income Taxes

Property tax abatements that are structured as deferrals of property taxes may be subject to income tax. The property owner may be required to pay income tax on the deferred taxes when they are paid in the future, though this does depend on the specific terms of the abatement agreement and the applicable local tax laws.

Property owners should also be aware that any improvements made to the property during the abatement period may increase the assessed value of the property. Should the owner seek to then sell the property after improvements are made, they may be subject to capital gains taxes based on the length the asset was held for. In addition, the greater the disparity between the sales price and the cost basis, the larger the potential taxable income.

The Bottom Line

While property tax abatement is a great incentive to purchase a particular home, it shouldn't be the deciding factor in your purchase. Make sure you really want the property and are comfortable with the location. Having an extra couple hundred dollars a month in your bank account won't make up for hating where you live.