Property Taxes And The Impact On Real Estate Investments
I was reading the paper this morning and came across the Tax Assessment Special Section. This got me thinking about the impact updated property tax assessments and property taxes in general can have on the Return on Investment (ROI) of your Real Estate investment.
Items that Impact the Tax Amount
There are three things that affect your overall property taxes. These include the tax rate, assessed value, and the exemptions that can be applied to the property if it is the primary residence of the owner. The tax rate will change from year to year but normally not drastically. In addition, there is little an investor can do to impact the change of the tax rate. For the investor, the assessed value and the change in exemptions on the property can change the taxes considerably. A wise investor takes this into account when calculating the potential ROI for the property.
Many investors look to purchase a property that is distressed, remediate the condition causing the distress and then either sell it for a profit at market value or utilize it as a rental property. A distressed property is a property that has lost market value due to the condition of the property. Renovating the property and increasing the market value may trigger a higher property assessment by the tax assessor.
Assessed Value of Property
Typically, the assessed value of a property for tax purposes is 33.33 percent of the market value. If the market value goes up, then the assessed value will follow. This will occur when the tax assessor reassesses the value of the property. Obtaining a Building Permit alerts the assessor to property improvements that are being done.
Tax Exemptions
The other item that will cause your property taxes to change is the removal of the tax exemptions that may be structured to the property. An exemption effectively lowers the assessed value of the property by the amount of the exemption. The government offers certain tax exemptions to qualified individual property owners that the investor needs to be aware of.
If a property is the primary residence of the owner, there is a $6000-dollar Home Owner exemption. This exemption encourages individuals to buy and live in the property they purchase. If the property is not being used as the principle residence, this exemption cannot be used.
Another common exemption is Senior Citizen exemption for home owners who are 65 and older. This exemption reduces the assessed value by $5000 dollars for citizens 65 years and older.
Check the Tax Records
Before you invest in a property, you should check the tax records to see the current assessed value of the property. You should also check to see what exemptions currently apply to that property. When checking the tax records for the property you can also determine the current tax rate. With this knowledge, you can then calculate the expected changes in your property tax for that property.
Typical Tax Increase Example
As an example, you purchase an investment property for $100,000 dollars. You plan to renovate the property and then use it as a rental property. You also calculate that when you are done renovating the property. The market value of that property would be $200,000 dollars.
You check the tax records at the county courthouse and you see that the assessed value of the property is $50,000 dollars. The tax rate for the past year was .086985. The home owner exemption of $6000 dollars was in effect as well. The current year tax was $3827.34 .
Utilizing the above data, you can calculate that the current market value of the property is calculated to be $150,000 dollars ($50,000/.3333). The current homeowner has had the taxes decreased by $521.91 ($6000 * tax rate) because the owner is living in the property and is getting the Home Owner Exemption.
After the property has been renovated and market value increased to $200,000 dollars, the taxes most likely will increase. They will increase two reasons. The first is that the assessed value will be reassessed by the tax assessor to be roughly $200,000*.3333 = $66,660. This reassessment will cause the new tax to be $5798.42 ($66,660* tax rate). This will be an increase of $5798.42-$3827.34 or $1971.08 dollars.
Since the property is being used as a rental property, the Home Owner Exemption of $6000 dollars no longer applies. Therefore, the property tax will not be lowered. Had the investor sold the property to a new owner who planned to live in it, then the Home Owner Exemption would apply and the tax would be reduced. This reduction would be $6000 * tax rate or $521.91 dollars.
Summary
Doing the due diligence to understand the potential change of your property tax is important when calculating the expected ROI on your investment. In addition, your monthly cash flow may be negatively impacted if the property taxes were not properly accounted for. In the example above, your monthly cash flow will be reduced by $164.25 ($1971/12) dollars per month.