Being a homeowner can be beneficial. You are allowed to deduct certain housing expenses that can lower your tax bill. As a taxpayer, it’s important to keep your tax bill as low as possible as it may keep you from having unexpected tax debt.
Luckily, homeowners have a number of tax breaks that they can take to lower the amount they owe. You are allowed to deduct specific housing expenses, such as property taxes and mortgage interest, on your annual tax return.
You are responsible for two types of housing-related taxes: property taxes and capital gain taxes. This can get confusing, especially if you are owning a home for the first time. We will go over these terms in detail, though.
In this article, we will cover the basics of real estate taxes, so you can learn what you need to know about property taxes. It’s important to work with a trusted tax accountant to ensure you get the most favorable tax treatment possible when it comes to real estate taxes.
Property Taxes
What are property taxes?
Property tax is an ad valorem tax paid on property owned by an individual or legal entity. Ad valorem tax is a tax based on the assessed value of an item, such as real estate or personal property.
In other words, if you own your home, you will need to pay property taxes on it. The amount of property tax you have to pay is determined, in part, by your local government. If you’ve ever wondered how that speed bump got financed at your kid’s school, it could be from your property tax dollars!
How are property taxes calculated?
To calculate the property tax you owe, multiply the assessed value of the property by the mill rate and divide by 1,000. To understand this, you will need to know the assessed value of the property and the mill rate. Each of these terms will be identified in this post.
Example One
If the assessed value is $50,000 with the mill rate of 20 mills, the property tax bill would be $1,000 per year ($50,000 X 20 = 1,000,000/1,000 = $1,000 per year).
Example Two
If the assessed value is $100,000 with the mill rate of 50 mills, the property tax bill would be $5,000 per year ($100,000 X 50 = 5,000,000/1,000 = $5,000 per year).
Note
These terms will be further clarified as this article progresses. So, if you are new to property taxes, don’t worry about any confusion you may be experiencing. We will sort it out.
What is the assessed value?
To clarify things, the assessed value is NOT the appraised value or market value; it’s not how much you can sell your home for or how much it’s worth. Your local government’s tax assessor determines the assessed value of your home. It’s usually an amount lower than the market value, which is a good thing because you pay property taxes on the lower amount.
Would you like to know what the assessed value of your home is? Take a look at your most recent tax bill or do a search of properties on your county or city tax assessor’s website.
What is the mill rate?
Millage or mill rate is the amount of tax payable per dollar of the assessed value of a property. It’s a figure that represents the amount per $1,000 of the assessed value of the property, which is used to calculate the amount of property tax. One mill is one dollar of tax for each $1,000 of assessment.
What is the property tax rate?
The property tax rate is determined by your local government. Your property tax rate can change from time to time, so understand the rate is not set in stone. Instead, tax hikes and property reassessments can change how much you owe in property taxes.
Once you know your property tax rate and have the assessed value, you can determine the amount of property tax you owe. The assessed value multiplied by the property tax rate will give you the property tax amount.
If you don’t have the mill rate of your property, the property tax rate will help you determine how much you will owe in property taxes.
How much is too much when paying property taxes?
According to Dave Ramsey, your monthly mortgage payment (including the property taxes you must pay) should be no more than 25% of your take-home pay. Let’s look at a few examples of how the different property tax rates affect your finances in the long run.
Example One
You are looking at two houses that cost the same amount, $250,000. They both have the same assessed value of $200,000. The tax rate on the first house is 1%; the tax rate on the second house is 2%. How will this affect your tax bill?
Answer: The annual property tax total of the first house would be $2,000 ($200,000 X 1%) or approximately $166.67 per month. The annual property tax total of the second house would be $4,000 ($200,000 X 2%) or approximately $333.33 per month. That’s a difference of $2,000 per year! This is why when shopping for a home, it’s best to work with a qualified Realtor.
Example Two
This time, you are looking at two houses that have the same tax rate of 1%. One home has an assessed value of $100,000, and the other home has an assessed value of $120,000. How will the difference in the assessed value of these homes affect your tax bill?
Answer: The annual property tax of the $100,000 home would be $1,000 ($100,000 X 1%), which would be $83.33 per month. The annual property tax of the $120,000 home would be $1,200 ($120,000 X 1%). These homes could have the same asking price, but recall that the assessed value is different. The difference in the tax bills for these 2 homes would be $200 per year.
Will I still need to pay property taxes once I pay off my home?
Unfortunately, as freeing as it is to have no more mortgage payments, you will still need to pay property taxes. Your local government will still collect property taxes to pay for things like construction and road repairs.
Once you have paid all of your mortgage payments, you should set aside the amount of your property taxes, so you will not receive an unexpected tax bill.
How do I pay my property tax bill?
According to Dave Ramsey, if you are already paying your monthly mortgage on time, you are probably already paying your property tax bill; you just didn’t know it. Dave explains that the typical mortgage payment includes interest, principle, homeowner’s insurance, and property taxes. But, you shouldn’t be so sure this is automatically taken care of.
Basically, there are two ways to pay your tax bill: (1) Set aside a monthly amount in an escrow account to pay your annual tax bill. (2) Pay once a year or every 6 months when your tax bill comes along. Typically, you can pay online, or you may write a check. Talk to your tax accountant or real estate professional if you have more questions on this.
What are the different property tax deductions?
You are allowed to deduct up to $10,000 for a combination of property taxes and either local and state income taxes or sales taxes. You may deduct up to $5,000 if married filing separately (MFS).
This is just one of the reasons it is beneficial to file a joint tax return. For more information on whether to file MFS (married filing separately) or MFJ (married filing jointly), please review this article.
Remember, you are also permitted to deduct mortgage interest on your tax return. You will, however, need to itemize your tax return when filing your annual return. To take property tax deductions, you will need to use Schedule C. For more information on what you can deduct on Schedule C, please check out this article.
How can I dispute a property tax bill?
You are allowed to dispute your property tax amount if you think it is inaccurate. You can challenge the assessed value, which may lower your tax bill if the local assessor deems your property to have a lower assessed value. How can you do this?
First, you can look at comparable homes’ assessed values. Ask your real estate professional or tax accountant to help you with this if you cannot find the information online.
Second, you can talk to your local tax assessor regarding the assessed value of your home. You may wish them to do a more current tax assessment so that the assessed value is more accurate.
Finally, you may be able to appeal your case with the tax appeals board.
Capital Gain Taxes
What is a capital asset?
Capital assets are investments, such as property or real estate. For businesses, a capital asset is an asset with a useful life that is longer than a year and that is not intended for sale in the regular course of the business’s operation. In other words, your new home or office building is a capital asset.
What is a capital gain?
A capital gain is the profit you receive from selling a capital asset for more than you paid for it. A capital gain cannot be realized until you sell the asset. A capital gain occurs when you sell an asset for more than your adjusted basis.
Check out Publication 551: Basis of Assets to learn how to calculate your adjusted basis. A capital gain is always a positive amount; it’s equal to the selling price of your home or property less the purchasing price of the home.
What is short-term capital gains tax?
Short-term capital gains tax is the tax on capital gains for capital assets held for one full year or less. Short-term capital gains are treated as “ordinary income” for the 2020 tax year, which means that if you fall under the tax bracket of 22% for the 2020 tax year, your short-term capital gains will be taxed at 22%.
To determine your filing status (and the amount of your short-term capital gains tax), check out the 2020 tax rates for all filing statuses. Once you have determined your tax rate, you can use that rate to calculate the tax you owe on any capital gains.
Example
If your home sells for $200,000 and was purchased at the price of $180,000, your capital gain would be $20,000.
Next, you will need to ask yourself, What will be my filing status for the 2020 tax year? If you will be filing the single filing status and your income was $40,500, you would have a tax rate of 22%, according to the 2020 federal income tax brackets and rates.
The capital gains tax would thus be $4,400 ($20,000 X 22%).
What is long-term capital gains tax?
Long-term capital gains tax is the tax on capital gains for capital assets held longer than a year. You receive a more favorable tax rate for long-term gains because the government encourages long-term investments, so if you invest in land or property, you will get more tax benefits. Here are the rates for long-term capital gains for the 2019 and 2020 tax years.
2019 Tax Year Rates for Long-Term Capital Gains
| Long-Term Capital Tax Rates for 2019 Tax Year | Single Filing Status | Married Filing Jointly Filing Status | Head of Household Filing Status | Married Filing Separately Filing Status |
|---|---|---|---|---|
| 0% | $0 - $39,375 | $0 - $78,750 | $0 - $52,750 | $0 - $39,375 |
| 15% | $39,376 - $434,550 | $78,751 - $488,850 | $52,751 - $461,700 | $39,376 - $244,425 |
| 20% | Over $434,550 | Over $488,850 | Over $461,700 | Over $244,425 |
2020 Tax Year Rates for Long-Term Capital Gains
| Long-Term Capital Tax Rates for 2019 Tax Year | Single Filing Status | Married Filing Jointly Filing Status | Head of Household Filing Status | Married Filing Separately Filing Status |
|---|---|---|---|---|
| 0% | $0 - $40,000 | $0 - $80,000 | $0 - $53,600 | $0 - $40,000 |
| 15% | $40,001 - $441,500 | $80,001 - $496,600 | $53,601 - $469,050 | $40,001 - $248,300 |
| 20% | Over $441,500 | Over $496,600 | Over $469,050 | Over $248,300 |
Example
If you purchased a piece of land for $7,000 and sold it for $10,000, your capital gain would be $3,000 ($10,000 less $7,000).
If you fall into the MFJ (married filing jointly) filing status and you jointly make $100,000, your long-term capital tax rate would be 15%. The tax you would need to pay would be $450 (15% of the $3,000 profit you had). Your end profit would be $2,550 ($3,000 profit less $450 taxes).
What does a cost basis mean?
Capital gains are the difference between the cost basis of an asset and the selling price. Cost basis is what you paid for the capital asset plus certain allowable costs of maintaining and selling the capital asset.
This is especially applicable in real estate transactions. To calculate the capital gain, you take the selling price less the cost basis (the purchasing price plus certain allowable costs incurred when maintaining and selling the capital asset). Let’s look at an example.
Example
An example would be if you purchased a home for $400,000, and it cost you $100,000 to maintain and sell it. If you sold your home for $600,000, your capital gain would be $100,000 ($600,000 less [$400,000 + $100,000]).
How can I minimize the taxes on capital gains?
There are many ways to lower the amount of taxes you need to pay on capital gains.
First, I highly recommend offsetting capital gains with any capital losses. A capital loss is equal to the selling price of your capital asset less the purchasing price of the asset.
So, if you purchased a property for $100,000 and sold it for $80,000, your capital loss would be $20,000 ($100,000 less $80,000). If you have a capital gain of $30,000, you could use the $20,000 to offset it, so you would only pay capital gains tax on $10,000 ($30,000 less $20,000).
The second recommendation I have when purchasing real estate property (or any capital asset) is to hold on to the property for more than a year. Since the long-term capital gains tax rates are more favorable, it’s best to keep capital assets like real estate property for one year or longer.
Finally, while this may not affect your capital gains tax, it’s crucial that you keep relevant, accurate, well-organized documentation related to your capital assets. If you become one of the few taxpayers who are audited, you’ll want to be prepared. Hold on to any backup material related to your capital assets, and keep it well organized, so you will be ready if the IRS comes knocking at your door.
Conclusion
Do you have further questions about real estate matters? Need help understanding the types of property tax or just want a qualified tax professional to help you out? We are here to help! We have wide experience in the real estate arena.
Property owners can benefit from the help of a tax accountant, so turn to the best. A qualified tax consultant can help you best comprehend tough subjects like real property, tax laws, and tax levies. The right tax professional can also help you in the event of an audit. We will be there for you every step of the way and can help you find the most advantageous tax results.
Do you need help understanding taxes or need help in paying your tax bill? Want to get the best advice on how to lower your tax bill or increase your tax refund? Please reach out to us; we will gladly help you with your business or tax needs. You can trust Indiana’s tax expert!
