How Property Taxes are Calculated

Every year, millions of homeowners pay property taxes. In most situations, when the tax bill comes, if it seems reasonable, they pay it and move on with their lives. That being said, to make sure you are not being overcharged on property taxes, it's important to understand how they are calculated and how property values are determined.

Determining Property Taxes

Property taxes serve as a major source of income for the federal and state governments. In most cases, these taxes come in the form of a percentage, where many different councils, boards and legislatures will decide the appropriate amount of tax revenue that needs to be raised. They will have a hearing on the budget to decide the amount of money that will be needed so the government can cover its expenses with no financial challenges in the year ahead. The services that are normally funded by property taxes include education, emergency services, transportation, libraries and parks, as well as different recreational activities.

Calculating Property Taxes

Property taxes are calculated through the use of the mill levy and the assessed property value.

Mill Levy or Millage Tax

The mill levy is simply the tax rate levied on your property value, with one mill representing one-tenth of one cent. So, for $1,000 of assessed property value, one mill would be equal to $1. Tax levies for each tax jurisdiction in an area are calculated separately, and then all the levies are added together to determine the total mill rate for an entire region. Generally, the city, county and school district each have the power to levy against the properties in their boundaries. So each entity would calculate its required mill levy, and it would all be tallied up to equal the total mill levy.

As an example of a mill levy calculation, suppose the total assessed property value in a county is $100 million, and the county decides it needs $1 million in tax revenues to run the county. The mill levy would simply be $1 million divided by $100 million, which equals 1%. Now, suppose the city and school district calculated a mill levy of 0.5% and 3%, respectively. The total mill levy for the region would be 4.5% (1%+0.5%+3%), or 45 mills.

Assessed Value of Property

Property taxes are calculated by taking the mill levy, like we determined in the previous example, and multiplying it by the assessed value of your property. The assessed value is a yearly estimation performed to decide the reasonable market value for your home based upon prevailing local real estate market conditions.

The assessor will review all relevant information surrounding your property to make an estimate of the overall value. To provide you with the most accurate assessment, the assessor must look at what similar properties are selling for under the current market conditions, how much the replacement costs for the property would be, the maintenance costs for the property owner, if any improvements were completed, the amount of income you are making from the property, and the amount of interest charged to purchase or construct a property comparable to yours.

After the assessor has this information, there are three ways that your property will be valued:

1. Performing a Sales Evaluation

The assessor will value your property based on similar sales that have taken place in the area. As this method is being used, it is important to look at overpricing, underpricing, the location of the property and the overall state of the property.

2. The Cost Method

This is when the assessor determines your property value based on how much it would cost to replace your property. If the property is not new, assessors determine the amount of depreciation that has taken place and how much the property would be worth if it was empty.

3. The Income Method

This method is based on how much income you would make from the property if it were rented. Using this method, the assessor must be sure to consider factors such as costs for maintaining the property, cost to manage the property, insurance, taxes and the return that you could reasonably anticipate from the property. After determining market value for the property, the assessed value will be determined by taking the actual value of the property and multiplying it by an assessment rate. The assessment rate is a uniform percentage, varies by tax jurisdiction, and could be any percentage below 100%. After getting the assessed value, it is multiplied by the mill levy to determine your taxes due.

For example, suppose the assessor determines your property value is $500,000 and the assessment rate is 8%. The assessed value would be $40,000. Taking the mill levy of 4.5% we calculated previously, the tax due would be $1,800 ($40,000 x 4.5%).

The Bottom Line

Property taxes can be very confusing for many homeowners. To ensure that you are paying the right amount in property tax, you must understand how the property is valued and how the taxes are calculated.