How do property taxes work?

Taxes have been frustrating and confounding people for millennia, but it wasn’t until 1066 that William the Conqueror came up with the novel idea of a property tax. A progressive idea at the time, property taxes don’t just impact the noble elite anymore; they’ve become an important component of government budgets and are paid by anyone who owns a house. Property taxes may fund local and community services, schools, infrastructure, and other state- and community-level projects.

All homeowners must pay property taxes, but not all property taxes are equal. Just know that if you’re buying a home, you’ll have to factor property taxes into your monthly budget.

What are property taxes?

Property taxes are paid on property owned by an individual or other legal entity, like a corporation. Usually, property taxes are considered an “ad valorem tax,” which means they’re calculated based on the assessed value of property. (Some personal property taxes, like excise taxes on boats or cars, are also ad valorem taxes.)

State and local municipalities levy property taxes in the United States, and the amounts vary widely between states and even adjacent cities or towns. As mentioned before, governments use assessed taxes for services, ranging from water and sewer improvements to law enforcement, infrastructure projects, schools, and beyond.

The states with the highest property taxes are New Jersey, Illinois, and New Hampshire. The states with the lowest property taxes are Hawaii, Alabama, and Colorado.

When you’re looking to buy a home for a home, your real estate agent can let you know what the property taxes have historically been for a listing (it’s usually on the MLS). You can also ask the seller how much you can expect to pay. 

Property tax vs. real estate tax

While the term property tax is often used interchangeably with real estate tax, they’re not exactly synonymous. A real estate tax is a tax on owned real estate — a type of property — and you can use it interchangeably with “property tax” unless you’re talking about a personal property tax. Personal property taxes include movable assets, like vehicles, but exclude real estate.

Basically, real estate tax is a property tax, but a property tax is not necessarily a real estate tax. As of 2019, 43 states tax tangible personal property in addition to real estate, so it’s important to at least understand the difference.

How to calculate property taxes

The way property taxes work is that your local tax authorities set a tax rate and then apply it to the value of your home. The basic formula is: Property Tax = Assessed Value x Tax Rate.

How the rates and values are determined though depend on the government, which is why property taxes can vary greatly by state, county, and even city or town.

Nearly all local property tax codes include mechanisms to allow property owners to discuss or contest their tax rate and the value of their home. 

1. Determine the home’s value 

You don’t typically have to pay taxes on the market value of your home; you only pay taxes on the assessed value of your home. This is based on your state’s assessment ratio, which is the percentage of your property’s market value that is actually subject to tax rate. 

For example: 

• Your home’s market value is $400,000.
• The state’s assessment ratio is 60%.
• The home’s taxable value, or assessed value, is $240,000. (60% of $400,000=$240,000)

The tax assessor (who is sometimes an elected official)  appraises your home periodically, maybe once a year, every three years, or every five years depending on where you live and how tax laws work in that jurisdiction. 

2. Apply the tax rate

Property tax rates come in mileage rates, which are expressed as a tenth of a penny (or $0.001). This is how much tax you’ll pay for every $1,000 your home is worth. 

Multiply the mileage rate by your home’s assessed value to find out how much your property taxes are. Here's an example:

• Your millage rate is 0.005
• That means you pay $0.005 for every $1,000 in home value
• 0.005 * 400,000 = $2,000 — this is what you'll pay in property taxes

The millage rate is usually a composite of a few different rates, like one for schools, one for the city, etc. This is also why the amount of property taxes a homeowner pays can vary wisely within states. 

Most authorities recalculate the tax rate annually to keep up with current market conditions.

How do you pay property tax?

Most of the time, property taxes are rolled into a homeowner’s monthly mortgage payment, which makes them very easy to pay. Your mortgage provider puts the property tax money in an escrow account and sends it to your local tax authority on your behalf when the bill comes due.

Homeowners may also choose to make annual or semi-annual payments directly to a tax authority. You may even be able to do so online, the way you do with a utility bill. However, mortgage lenders often restrict this option because it reduces the chances of the home going into tax foreclosure.

If you fail to pay taxes, your local tax authority may put a lien against the property.

Can you deduct property taxes?

Yes, you may deduct property taxes on your federal tax returns, as well as your state income tax or state sales tax (but not both). The state and local tax (SALT) deduction allows you to deduct up to $10,000, but you must itemize your tax deductions to take the SALT. Taking the standard deduction ($12,950 for 2022) is easy, but if you paid $9,000 in property tax, you likely may deduct more than the standard. Consult your tax professional to help you figure out what makes the most sense for your situation.

Related: Tax credits for first-time homebuyers

Property tax exemptions

In addition to deductions, some people may be eligible for property tax exemptions. Common exemptions include homestead exemption and “circuit breaker” programs. 

The homestead exemption reduces the taxable value of a primary residence by a predetermined amount, the rules for which vary by state. Circuit breaker programs reduce property tax liabilities for qualified people for whom the tax is a financial burden, like seniors, people with disabilities, and low-income homeowners. Again, the rules vary widely between states.

Tax deferrals are also available to qualified seniors and homeowners with disabilities, allowing them to defer payment until the sale of the property or death of the owner.

Nothing is certain except death and taxes. Fortunately, you only have to pay property taxes if you already own something pretty great. (Homeownership is one of the largest drivers of wealth.) Nobody likes to pay a tax on something they already own, but the amount you pay is reflective of your property and should be relatively easy to calculate and, once you make a purchase, pay to the local tax authority.