Summary: This week is all about property taxes! In part 1, we’ll discuss how to calculate property taxes: how they will likely increase after you purchase a rental property and how to predict how much it’s likely to go up. In Part 2, we’ll discuss how to challenge them over time. Would you like to lower your property taxes? Maybe that’s the better question…
To some of you, reading an entire post on property taxes is probably not your idea of fun.
But stick with me here: this week is an important read for every real estate investor because property taxes are an important expense line item in your cash-on-cash calculations.
In this two-part series, we’re going to cover two important aspects of property taxes that every real estate investor should know about and understand.
First, we’re going to explore how to calculate property taxes. We’ll cover how to estimate what will happen to property taxes after you buy a rental property. This is because accurate estimates are important for predicting how your property is going to perform. Getting this wrong might completely wipe out your cashflow.
Second, we’re going to cover when and how to challenge your property taxes. This is an important concept for all investors because lowering your taxes means more money in your pocket.
Are you excited about property taxes now? If so, let’s get going!
How to estimate property taxes
When plugging the property tax expense into your cash-on-cash calculator, you need to be sure that this number is as accurate as possible.
Download the Short Term Rental Cash-on-Cash Calculator
Most people just plug the number that they see on Redfin or Zillow or the number given to them by their real estate agent. The problem is, the figure you get often isn’t accurate. At worst, it’s years old, making the expenses on the property look much better than its true performance.
The way to get the most accurate value when you calculate property taxes is actually to go onto the county website and look up the current property taxes.
Looking up current property taxes tells you what they are today but, what will your property taxes be next year after you buy the property?
Is there a way to predict property taxes after purchase?
The answer is, not exactly. But, there is a way to get closer than just plugging the current property taxes into your cash-on-cash calculator.
Odds are that anything you buy these days is going to be more expensive than what the previous owner paid for the property. (It’s not always the case, especially in a downturn, but more frequently than not, investment properties are usually sold after they’ve appreciated.) Since you’re probably buying the property for more, odds are that the city will reassess the property at a higher value the year after you buy the property since the purchase price establishes a new market value for the property.
Even if this doesn’t happen the very next year, it will likely occur not too far down the road. Especially since cities usually reassess property values every one to five years and base them on the property’s market value or a percentage of its market value.
You’ll likely face the biggest increase in taxes when you buy a property that hasn’t been previously sold for a long time or if you buy a property in an area where property tax assessments haven’t kept up with the market value. In either of these cases, you’re going to be in for a significant hike in property taxes.
So how can you get as close as possible to predicting what the new property taxes are going to be?
You can use the city’s/county’s mill rate to estimate future tax rates.
What is a mill rate?
Each city has a unique mill rate that they use to calculate property taxes.
One mill is equivalent to 1/1,000 of $1 (or $1 of tax for every $1,000 of assessed value).
Besides the basic city mill rate, your property may also be subject to different mill tax rates from more than one jurisdiction. (For example, from the county or the local school district.) This makes finding all the mill tax rates that may apply to your property a little more complicated.
I know this is an abstract concept, so let’s look at an example to make it clearer.
Example property: Duplex in Bellevue, WA
Let’s say you’re going to buy a $500,000 duplex in Bellevue, Washington.
Let’s say the owner bought the property 20 years ago for $80,000. If the property is currently assessed at $300,000, the owner is paying $2,463 dollars in taxes per year.
You know, once you buy this property, the city of Bellevue is likely to increase the property’s assessment.
Let’s just take the worst-case scenario: that the assessed value suddenly jumps up to $500,000. And if that’s the case, you need to find the city’s mill tax rate to figure out how much you could potentially owe each year.
The easiest way to do this is to simply search “mill rate” and the city of interest.
In Bellevue, I can see the city mill rate is currently $8.21. If the property’s assessed value increases to $500,000, I’ll be on the hook for $4,105 in property taxes per year ($500,000/$1,000 x $8.21).
If I wanted to confirm that there weren’t any other charges or other applicable mill tax, I’d also consider calling the city to confirm that the $8.21 mill tax was the only one applicable for this particular property.
A secondary benefit of calling the city is that I may also be able to gather some insights on how the city assesses property. Do they do it by market value? Do they base it on a percentage of market value? And are there any other taxes I need to be aware of that will affect this property?
Remember, using the mill tax in this way is a rough estimate of property taxes. This is because you’re not sure what the tax assessment is actually going to be in a year. However, at least this gives you a sense of the worst-case scenario that you can plug into your cash-on-cash calculator. Then you can decide if the numbers work and you want to make an offer.
This concludes Part 1 of our deep-dive on property taxes. In Part 2, we’ll cover how to challenge your property tax assessments and potentially lower the property taxes on your rental property.
