How Your Home's Value Affects Your Property Taxes

by Elizabeth Rosen, Contributor

The relationship between your home’s value and your property taxes is direct, if not a bit obvious. Property taxes are based on property values, so essentially, the more your home is worth, the more you’ll have to pay in property tax. The terms used to describe the property appraisal and taxation process can sometimes be confusing and sound redundant. Here is a run-down of the most important property tax-related terms, as well as an explanation of the property assessment process.

Your Home’s Value

It’s important to understand that your home’s purchase price is a completely separate number from its “fair market value” and its “tax assessed value.” Consider this when you are factoring in the cost of property taxes on your budget. The main terms used to describe a home’s value are explained below.

Fair Market Value (FMV)

The term “fair market value” (also called simply “market value”) refers to the price that a particular property (or other asset) would sell for in the current market. This means that both the buyer and seller are properly informed about the asset and that they are entering into the transaction voluntarily and for their own best interests. In other words, fair market value (FMV) is an estimate of what a willing buyer would pay a willing seller.

A property’s FMV is considered to be an accurate valuation of its worth. Many local property taxes are levied based on the FMV of the owner’s property. An older home will likely have lower purchase price due to its age, but its FMV and property taxes may be high.

Market Assessed Value

The term “market assessed value” refers to the price that a property would fetch on the open market in that particular year. A property’s market assessed value is determined by a government tax assessor, who looks at historical sales of comparable properties to make their calculations.

Tax Assessed Value (TAV)

The term “tax assessed value” refers to a figure that has been determined by the local (city or county) taxing authority. Depending on the locality, a property’s tax assessed value may be the same as its market assessed value or it may be a percentage of the property’s fair market value. In some places, county officials use an “assessment ratio” to determine a property’s tax assessed value (TAV). Your property’s TAV is then used to calculate your property tax bill for the year.

For real property, the TAV is established through three main valuation systems: the Sales Comparison Approach, the Cost Approach, and the Income Approach. These systems analyze your property against similar properties in the area. The Sales Comparison Approach looks at the sales of similar properties in the surrounding area, including traditional home sales, foreclosures, and short sales. The Cost Approach looks at improvements (such as swimming pools, finished basements, remodels, and the cost of construction) and depreciation (age), as well as natural disasters and any structural damage. The Income Approach looks at increases and decreases in rental trends.

Property Taxes

Property taxes are levied by local governments (counties, cities, municipalities) and are generally their main source of revenue. The money collected from property taxes are used to finance the local fire departments, police departments, public schools, road work, and other public services. Each locality follows different procedures for property tax assessments, so you’ll want to check with your county/city tax assessor for specifics regarding your area.

Property Appraisal / Assessment

The process for assessing property values varies from county to county. Some localities reassess properties every year while others reassess properties every few years. In general, real property is assessed using either the Cost Approach, the Sales Comparison Approach, or the Income Approach. Once the local tax assessor has determined your property’s fair market value (FMV), they apply an assessment ratio (in most counties) to arrive at the property’s tax assessed value (TAV). The assessment ratio is usually 80% to 90% of the FMV. Note that your property’s TAV may be lowered by certain allowable exemptions, such as a homestead exemption, disability exemption, or veterans exemption.

READ: Tips for Lowering Your Property Taxes

Home Improvements Can Add Value… and Raise Your Property Tax

While adding improvements to your home (i.e. upgrades and remodels) will increase its market value, this will also lead to an increase in its tax assessed value — meaning a higher property tax bill. It’s important to keep this in mind what you’re planning permanent home improvements such as a swimming pool, deck, porch, finished basement, or adding a garage.

On the other hand, if your property suffers any damage from a natural disaster (e.g., flood, fire, or wind), that will reduce the property’s fair market value and its tax assessed value, as well as your property tax bill.

Note that your property must be officially reassessed for any valuation changes to occur.

Conclusion

There are many factors to think about when you own your own home, from homeowners insurance to daily maintenance. Be sure you factor in the property taxes when making your housing expenses budget. If you’re a potential homebuyer, it’s a good idea to weigh the home’s property tax bill against other state and local taxes so you can see how much of your income will need to go toward taxes.